Markets Weekly podcast – 25 April 2022

Henk Potts (HP): Hello. It’s Monday, 25th April and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank. Each week I’ll be joined by guests to discuss both risks and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then consider whether now is the time to lock in rates. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Equity markets remained under pressure and volatility rose during the course of last week as investors reacted to slowing global growth forecasts, the intensification of COVID restrictions in China, and hawkish central banks.

In terms of equity market performance, well, US stocks fell for a third consecutive week. The S&P 500 closed the week down 2.8%. The Nasdaq, the technology market, is now down more than 9% in April, putting it on course for its worst monthly performance since 2008. Similar picture in Europe, perhaps a little bit less dramatic, but the STOXX 600 was off 1.4% over the course of the week, registering its biggest weekly decline since 4th March.

In terms of bond markets, well, investors have been reacting to the prospect of a 50 basis point hike, both the May and June Fed meetings, by pushing 2-year Treasury yields up to 2.71%.

Confirmation that Emmanuel Macron has won a second term did provide an element of relief for European markets. The centrist campaigned, remember, on a platform of business-friendly reforms, more emphasis towards that green transition, greater European Union integration. He’s very much been promoting a pro-NATO stance, but also suggesting that he will embark upon a strategy for regaining economic sovereignty. In terms of that political backdrop, the focus will now turn to the legislative elections, which take place on 12th and 19th June.

We know the International Monetary Fund has downgraded its growth forecast. It had been projecting higher average inflation, citing Russia’s invasion of Ukraine and China’s renewed virus crackdown. Now forecasting that global growth will slow to 3.6% in 2022, that’s down from its 4.4% projection back in January.

The Fund sees inflation averaging this year 5.7% in advanced economies, 8.7% in emerging and developing countries, although they are forecasting consumer price increases will slow to 2.5% and 6.5%, respectively, through the course of 2023.

The International Monetary fund also highlighted the rising risk that inflation expectations are becoming unanchored, prompting more aggressive central bank tightening.

Europe received a sharp downgrade with growth projected at 2.8% now for this year, that’s down from its 3.9% previous estimate. The IMF said the outlook remains uncertain and continues to be skewed to the downside. Those risks include an escalation in the war, increased sanctions on Russian energy, a flare-up of the pandemic, driven by more powerful COVID-19 variants, and a sharper slowdown in China.

In terms of our thoughts around the economic outlook, despite the reduction in global growth profile, our 3.3% projection for this year and next is still in line with the medium-term trend growth forecast. We expect Europe will eventually wean itself off its reliance on Russian energy, and commodity prices should stabilise. Supply chains should steadily improve as businesses overcome logistical constraints and capacity levels normalise. While it may feel, I think, very disconcerting to be bombarded by a seemingly endless barrage of negative headlines, it is important to remember that policymakers still have plenty of options.

If, as expected, inflation does indeed moderate into year-end, we can expect some of the intensity over the hiking narrative to ease as officials try to orchestrate a softer economic landing. Meanwhile, growth prospects should continue to be underpinned by solid labour markets, excess consumer savings built up during the course of the pandemic, and the recovering service sector.

Data last week showed the Chinese economy actually grew at a faster rate than expected in the first quarter. GDP expanded by 4.8% year-on-year, which is actually ahead of the 4.4% pencilled in by economists, and an acceleration from the 4% in the fourth quarter of last year. However, that was primarily driven by a surprisingly strong first two months of the year.

Figures for March highlighted how renewed COVID restrictions, the slump in the property market, and the war in Ukraine have been impacting household consumption, real estate, and exports. Remember, analysts estimate that up to 370 million people are currently affected by partial or total lockdowns in China, though strict lockdowns have stabilised, it’s come at an economic cost. Consumer spending has slumped and unemployment, in the world’s second-largest economy, has been rising.

Retail sales contracted by 3.5% in March. That’s the first decline since July 2020 and their lowest level since the start of the pandemic. In terms of support, well, the People’s Bank of China’s been cutting lending rates, reducing the reserve requirement ratio, and promised to step up further support. However, so far, those measures have fallen short of expectations and that’s been reflected in terms of market performance.

If you look at Chinese equities, they’ve certainly been under pressure during the course of this year. The CSI 300 index is down another 4% this morning and is off 21% year to date. The yuan has registered its largest five-day loss against the dollar in over six years. In terms of our headline forecast, I think, given the containment measures are expected to be in place for a prolonged period of time, it’s no surprise that we have cut our China GDP growth forecast. We now think it will be 4.3% for this year, which, of course, is significantly below that official 5.5% target level.

Moving on to euro inflation, which accelerated in March to its highest level on record, consumer prices rose 7.4% year-on-year after rising 5.9% in February. Core consumer prices, which strips out volatile food and energy components, rose 2.9%. In terms of those headline figures, it’s no surprise that energy continues to be the major driver. Energy prices surged 44% last month, year-on-year. The elevated print, of course, will increase pressure on the European Central Bank.

Policymakers are starting to become more vocal about the need to speed up the tightening timetable. Officials have already indicated that net asset purchases under the asset-purchase programme will be concluded by the third quarter, which in theory, I suppose, could pave the way for a rate hike in the second half of this year. The exact timing of that first hike is likely to be determined by the incoming data.

I suppose evidence of a wage price spiral or a dis-anchoring of inflation expectations could force the Governing Council into an earlier hike, perhaps as early as September, though the risk of that early hike to us still remains low, and we still see that first increase, in terms of that hiking cycle, to come through in 2023 given the vast level of economic uncertainty that we see across the region.

So that was the global economy and financial markets last week. In order to discuss US interest rate forecasts and how investors should be positioned, I’m pleased to be joined by Michel Vernier, who’s Head of Fixed Income Strategy with Barclays Private Bank.

Michel, great to have you with us today. Let’s get straight into the questions and let’s start with the US central bank. We know that markets and the Fed have finally appeared to be aligned. What can we expect from the Fed meeting in May, and do you see any surprises?

Michel Vernier (MV): Yes, hello, Henk. By now the money market has fully priced in a 50 basis points move by the Fed. And by the latest, since last Thursday, a 50 basis point hike is well telegraphed by the Fed as well. You mentioned the IMF panel last week. During that panel, Fed chair Powell said I would say that 50 basis points will be on the table for the main meeting.

So market participants certainly will try to get more insights about the further rate path, so investors would like to know how much urgency sees the Fed at this point. If inflation is heating up further from the record levels and if there are no signs of a cooling down, how much water does one pour onto the flame without causing too much collateral damage? This seems the crucial question. But the Fed seems to have cut this exercise now in two halves.

So, it’ll first deal with inflation now as long as still effective, and before it gets entirely out of control. The period afterwards will then be managed according to incoming data. That’s how it seems.

So, if you ask about a surprise, now it would be a 75 basis points move as suggested by Fed member James Bullard, for example, or as forecasted by some brokers, but we don’t put too much weight on this for the moment.

HP: So, do you believe the market is currently pricing the Fed path correctly? What is our main scenario?

MV: Yeah, so apart from the next meeting, the market is pricing in 50 basis points for the meetings in June and July. So, together with 25 basis point steps for the remaining meeting, so 25 basis point hikes, this would take the upper target rate to 3% by year-end. The forward rate market peaks at short of 3.5% by comparison.

Now, this is well above the envisioned Fed’s own “dot plot” projection, which shows a peak at maximum 3% at this point. Now, we absolutely agree that the Fed has no time to lose and the latest comments of Jay Powell added another layer of urgency. So, perhaps the best way to describe the current level of alert is to recap the urgency stages.

So, stage one, well, we’ve passed that stage already, well, a year ago. There was no urgency. Let the economy run hot and look through the transitory nature. That was the Fed’s mantra. Then, we had stage two. Some urgency, we need to act nimble, the Fed then suddenly said, before inflation hurts the job market recovery. Now, since last week, we have stage three. Clearly, there’s the urge of the urgency level. So, the job market, the Fed is saying job market is too hot, we need to adjust demand.

So, will there be a stage four, ultra, and urgency? Well, it very much depends on timing with regards to inflation. And the idea is that the expectation is for some pull effects to kick in eventually over the year. We may have seen a glimpse of what could be a more dominating theme going forward from the latest inflation data in March. So, the components in March, which have constantly pushed inflation in the recent past and caused by the pandemic, they seem to have become a tad weaker. So, prices of second-hand cars, trucks, and prices around travel, for example, they are likely to bring inflation in the second half of this year down a bit.

And the Fed is expecting some of this trend to materialise and does not want to hike into the next recession. So over this year, or perhaps the beginning of next year, 50 basis points of the priced in hikes may be priced out again. We believe that inflation moderates short at 3% by 2023, by the way. So, a peak at 3% seems likely, but we would be cautious about the 3.5% rate level priced in currently.

HP: So, what are your thoughts on the market reaction to that expected path of policy? Would you have expected to see much higher yields, particularly at the long end?

MV: Yeah, it’s a bit of a conundrum. You know, there’s a strong belief in the market that growth may become a concern and this, together with higher demand from international flows and institutional buyers, have kept the long end so low by comparison, so long-end yields.

But the sheer uncertainty over how far the Fed will have to go in the end, the uncertainty over the inflation outlook, and the fact that the Fed will retire partly its Treasury bond portfolio on the balance sheet is enough breeding ground for even further volatility on the long end in our view. And this seems to be underestimated in a way. But we also see such higher yields, also partly due to our very own inflation outlook, as temporary.

HP: OK, Michel. Let’s get practical. Where should investors be positioned when it comes to bond markets currently?

MV: Well, we stay defensive with short and medium bonds, but are getting now increasingly prepared to add at the longer end, as higher yields materialise in a drip-feed approach. We have seen during last week’s 20-year US Treasury bond auction that there’s already large demand from institutional buyers at 3% levels, maybe a bit too early from the institutional buyers, but, again, if 3% or much higher levels are going to materialise, there are some opportunities to add some yields at the longer end as well.

HP: Well, thank you, Michel, for your insight today. We appreciate you sharing your thoughts on what is set to be an interesting period for both policymakers and bond market investors.

Let’s move on to the week ahead. In the US on Thursday we expect first quarter GDP to be supported by personal consumption, equipment investment, and private inventories, but offsetting effects mainly coming through from net exports. We look for the advanced estimate of those first-quarter GDP numbers to come in a 1.7% quarter-on-quarter.

The other big datapoints to watch out for come on Friday in the United States. We get personal income spending and inflation data. We expect personal income growth to slow a bit from the prior month, mainly reflecting wage base effects as wage growth in February was strong, boosted by a large jump in weekly work hours. We expect nominal personal spending to be boosted by higher PCE inflation.

Speaking of which, we expect headline PCE to rise 6.8% year-on-year in March, driven mainly by food and energy prices similar to what we’ve seen in terms of CPI and PPI data for the same period. Excluding food and energy, we expect core PCE to increase by 0.35% month-on-month, or 5.3% year-on-year, a touch higher than the core print for March, driven by strong increases in services, healthcare, and transportation services.

So with that, we’d like to thank you once again for joining us. We will, of course, be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.