Markets Weekly podcast – 4 July 2022

Henk Potts (HP): Hello. It’s Monday, 4^th July 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 the outlook for FX markets. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

The global bounce off bear market territory lost traction last week as investors continued to assess the threat of inflation, the impact of higher interest rates, and the risk of a recession versus attractive valuations and the ability of policymakers to deliver a softer economic landing.

Fears of a recession was a dominant theme, with both equities and bonds notching up their highest first-half losses in decades. The MSCI World stock index generated its biggest fall since its creation in 1990. The S&P 500 was down 21% over the course of the first six months of the year, its biggest decline since 1970 when high inflation, of course, was also unnerving investors.

Technology is where we’ve seen some of the most intense selling. The Nasdaq was off 30%. European equities fell 17% through the first half, their biggest decline since 2008. The sell-off has been broad-based, with every sector, apart from energy, in negative territory.

In bond markets, there was a late rally in June for government bonds. Ten-year Treasury yields tumbled below 3% last week, but Treasuries fell 9% in the first half of the year. Since 1973, US government bonds have only posted five annual declines.

In Europe, government bonds declined 13%. Corporate bonds were also deep in negative territory over the course of the first six months of the year, down 14% in the United States, 12.5% in Europe.

Looking at currencies, the dollar has just notched up its best quarter since 2016, the dollar index up around about 9% year-to-date. The Japanese yen has been under pressure, which has now, in fact, plunged 15% in the first half, now its weakest level since 1998.

Bitcoin, well, it’s been a rough ride for cryptocurrencies. It was down around 60% in the first half of the year and has just registered its worst quarterly loss in 11 years. But as a reminder, past performance, we often say, is not an indicator of the future. In fact, if you look at the previous five biggest first half S&P 500 sell-offs, they were all followed by remarkable recoveries in the second half of the year. For example, in 1970 the S&P 500 bounced back in the second half to the tune of 27%.

We should remember, of course, that valuations are attractive. Global equities are now trading on a forward price earnings multiple of 14 times. That’s down from 20 times at the start of the year, and below the 10-year average of 15.4 times. And while earnings expectations will need to be revised lower, we still expect earnings growth to be positive during the course of this year.

On the data front, the latest eurozone inflation print piled pressure on the European Central Bank to increase the intensity of its normalisation timetable. Eurozone inflation registered a fresh record high in June, CPI printing at 8.6% year-on-year driven by food and fuel. Nearly half of the 19 eurozone countries have now reached double-digit inflation. We forecast that inflation won’t peak until September. We think it will come in at around about 9% at that point, followed by only a gradual moderation.

At its annual forum in Sintra, president Lagarde reiterated the era of negative interest rates will come to an end over the course of the coming months, as the central bank dramatically pivots away from promoting growth to curbing inflation.

She stated the central bank will push ahead with that 25 basis point rate hike in July and by more in September if the inflation outlook persists or deteriorates. Our current expectation is the ECB will hike by 50 basis points in September, a further 25 basis points at the October meeting, after which we anticipate a pause in policy, the deposit rate at plus half of 1% as growth and inflation starts to trend lower.

There were mixed messages coming through from the US economy. On the downside, the Conference Board Index of Consumer Confidence in June extended the decline that was registered in May. Concerns about elevated prices, particularly food and gas, weighed on the index. There was also a downgrade to the current assessment of business and the labour market.

The Conference Board reading, alongside the steep decline in the University of Michigan reading, suggests that demand for higher-ticket items will continue to moderate in the coming months, while house buying is expected to suffer from high home prices and the increase in mortgage rates, although any easing of consumer spending is likely to be less aggressive than in previous cycles, given labour market strength and the excess of savings that’s been built up during the course of the pandemic.

One of the reasons we remain relatively optimistic, however, about the outlook for the US economy is the robust levels of business investment. Figures for last month show that demand for durable goods, remember, these are items that are expected to last at least three years, increased by seven-tenths of 1% in May, adding to the 0.4% increase that we saw in April.

Companies have been increasing their investment in machinery and equipment in an effort to boost productivity and overcome supply disruptions, labour shortages, and higher energy costs.

We expect private investment, a measure of how much a US company is looking to invest domestically, to grow by around about 8% during the course of this year and be supportive of US growth.

One of the most common questions we get is around the state of the UK property market. After booming in the post-pandemic world, the UK housing market continues to deliver impressive price growth. However, recent data does show that house price appreciation has been slowing. Numbers from the Nationwide showed prices grew three-tenths of 1% in June. That was below the half of 1% expected, and the slowest rate since September.

The annual pace of growth eased to 10.7%, from 11.2% in May. This moderating trend is expected to continue through the course of this year, as rising mortgage rates and declining real incomes reduce momentum. Furthermore, the Bank of England’s lending survey suggests that banks are starting to tighten the availability of secured credit. Alongside that, the Royal Institute of Chartered Surveyors’ survey shows early signs of softening in the balance between buyers’ enquiries and instructions, falling to levels not seen since late 2020.

The easing of those indicators would be consistent with flat house price growth by the end of this year. Nevertheless, in the medium term we continue to believe that the UK housing market will be underpinned by structural supply and demand imbalances, inventories remain close to their lowest, robust labour markets, and strong demand from international buyers, particularly if sterling remains weak.

So that was the global economy and financial markets last week. In order to discuss the outlook for foreign exchange markets, I’m pleased to be joined by Marek Raczko, FX Strategist for Barclays Investment Bank.

Marek, great to have you with us again today. Let’s start off. What are the key issues that FX markets will be focusing on over the course of the next quarter, and where do you see the US dollar?

Marek Raczko (MR): Great. Thanks, Henk. Thanks for having me here. Well, look, clearly this is a very challenging environment for the global economy. We have, and have been already seeing a soft budge in the global growth, let’s not call it recession yet, but we can clearly see that the growth momentum is slowing down, and at the same time the inflation prints are still very high, and inflation pressures are quite broad-based and keep on pushing global central banks to deliver more and more of a tightening policy.

So this is a clear key issue in the global market. The other issues are essentially risks which are weighing on a global risk sentiment. The two major risks out there are gas supplies to Europe, how they are going to be settled, how they are going to be fixed given the ongoing war in Ukraine. And then the other risk is, of course, still COVID, and, in particular, Chinese policy which is focused on a zero-tolerance COVID policy that leads to temporary lockdowns of particular parts of the Chinese economy. That leads to another pressure on those global value chains, which, of course, propagate through inflation.

So this is sort of a global backdrop, and in this global backdrop, you know, we actually think that the dollar probably will continue to appreciate for another quarter. Don’t get us wrong. We do think that, you know, the dollar is already overvalued, but in this environment, with the risks still not subsiding, and with this sort of more prolonged tightening cycle from the Fed even into the slowing global economy, that essentially will favour a stronger dollar.

Our calling for 1.02 by the end of the third quarter, and only after that when we think that, you know, a lot will be already in the price and there will be already a momentum where inflation should turn and so signals that this tighter monetary policy is working. Then is the moment where we actually should see a catch-up from other central banks and to finalise the moment of dollar turning and looking, you know, beyond that, this upcoming quarter we actually think that then the dollar will eventually start weakening. But, near term definitely, you know, there is still some upside for the dollar.

HP: OK. So keeping that in mind, one of the main questions that FX traders will have to consider this year is whether the Fed can continue to hike even into a slowing economy and what that would mean in terms of global FX.

MR: So this is exactly the key point. We actually think that, yes, that the Fed will continue to hike into the slowing economy. We think that the Fed is essentially really focused now on inflation. This was in line with their communication. We’ve heard it being echoed by almost all the FOMC members out there.

And that essentially means that, you know, I told you about our euro/dollar call for 1.02, but that essentially means also that, 1) other central banks which are not actually offering rate hikes, their currency will be pressured, in particular the Japanese yen which is the only one holding onto their very dovish monetary policy. And others, well, it will a lot depend on your sensitivity to sort of global growth versus tighter financial conditions.

Here we find that, you know, currencies which always had a high beta, like Norwegian krone, could be particularly susceptible. Also, sterling recently has been showing that it is quite sensitive, so it might remain a bit volatile in this sort of environment and might also struggle.

While, you know, other currencies were, sort of, we will see that the local central banks are catching up or accelerating their tightening phase, they actually might decline. You know, the Canadian dollar will probably be supported by oil and by this Fed decision. We also think that, you know, that the scope for underperformance of Antipodeans is also somewhat limited. But again, they are exposed given the sort of global backdrop.

HP: OK. So, let’s pick up on some of those stories. What about the other major currencies? Where are there particularly interesting idiosyncratic stories that we should continue to monitor?

MR: I think the most interesting out there, for the time being, is essentially the Swiss franc. So the SNB has made a pivotal move, signalling not only hiking rates and signalling their hawkish monetary policy, but also essentially highlighting that they are no longer looking into just buying foreign currencies one way, meaning that they are putting some sort of cap on any type of Swiss franc appreciation. They’ve sort of highlighted that now the FX intervention policy might be a bit more symmetric.

In this sense, they, after many years, have opened the doors, or opened the way, for Swiss franc appreciation. This is essentially, it was a surprising turn, but it was something that should have been expected and we’ve been flagging it, because essentially inflation pressures are also rising in the Swiss economy.

They do have a lot of imported inflation. So, because of that they essentially can absorb a lot of this sort of external inflation shock by just allowing their currency to appreciate. So we actually think that, you know, we already got into the parity and we think we can go below parity against the euro for the Swiss franc, in particular in the next quarter, just based on this mechanism that now the Swiss franc will have the scope to outperform.

Other main stories, I think Japan is a very interesting one where we are expecting that only in September there’s going to be a turn in their monetary policy, but so far as long as they keep their monetary policy in their very dovish stance against almost every other central bank pushing for hikes, this is a difficult environment for the yen to appreciate.

Also, bear in mind that if the oil price and energy prices stay high, then this also weighs on the yen. So this is a sort of a mix, global mix, which is really challenging for the yen out there.

Now, I think the last currency that I would like to mention, I think from Scandis, Norwegian krone is actually quite an interesting currency because it has been sensitive to those global narratives, global risks, global equity market moves, but at the same time we see that the central bank is hawkish, delivering a policy tightening. At the same time, the economy is quite closely linked to oil and, of course, gas. If anyone could be a beneficiary of all those gas supply tensions in Europe, that could be, in particular, Norway and Norwegian krone.

HP: Well, thank you, Marek, for sharing your views on the outlook for the currency majors. Over the course of the coming quarters, it will certainly be interesting to see how long the dollar strength can continue to play out.

Moving on to the week ahead, where the focus will be on the US employment report on Friday, where we expect the US economy created 275,000 jobs in June. That’s a step down compared to 390,000 in May.

We look for wages to grow by three-tenths of 1% month-on-month to 5% year-on-year. We look to the unemployment rate to hold steady at 3.6%.

With that, I’d like to thank you once again for joining us. I hope you found this update interesting. 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.