Markets Weekly podcast 14th November
14 November 2022
Against a backdrop of high inflation, war in Ukraine and political instability, guest Bhaskar Gupta, our Head of FX Distribution UK, shares his thoughts on the major trends shaping FX markets in 2022. He’s in conversation with our Market Strategist and host Henk Potts who turns his attention to turmoil in cryptocurrencies, US inflation, and the global economic outlook for 2023.
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Henk Potts (HP): Hello. It’s Monday, 14th November 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 with 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 discuss the prospect for foreign exchange markets. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
There was green on the screen and the bulls were back in business last week, as investors reacted to a moderation in US inflation, an easing of COVID restrictions in China, and gridlock in Washington. Even the turmoil in cryptocurrencies and some disappointing earnings couldn’t hold back the “risk-on” tide as equity markets rallied, Treasury yields eased, and the dollar weakened.
The S&P 500 surged 5.9% during the course of last week, led by technology, which was up 10%, followed by a 9.2% jump in communication services, and a 7.7% rise in materials. European stocks had their best week since March. The STOXX 600 was up 3.7%. The dollar registered its biggest weekly drop since March 2020 and was down 3.5% over the course of the trading week. The ten-year Treasury yield was down to 3.81%.
Cryptocurrencies plunged to their lowest levels in a year. This was after FTX, one of the largest exchanges, filed for bankruptcy due to a liquidity crisis amid rumours of a mishandling of client funds and an investigation by US agencies. Its collapse reverberated through the system as exchanges blocked transactions and liquidations increased.
Bitcoin has been trading back below $16,000 this morning and has lost 75% of its value over the course of the past year.October’s US inflation report offered some encouraging evidence that price pressures are starting to ease. The annual consumer price reading fell from 8.2% in September to 7.7% in October, that’s the slowest rate of increase during the course of this year. Core inflation also decelerated to 6.3%. That compares to the 40-year high of 6.6% in September.
We believe that the peak in US inflation is now behind us and that the reading will slowly grind lower over the course of the next 12 months. We expect headline CPI to print at 6.9% in December before gliding all the way down to 2.5% at the end of 2023, which suggests a step down to 50 basis points at the December Fed meeting.
The US midterm elections failed to produce the “Red Wave” the Republicans had hoped for, as Democrats outperformed the opinion polls and kept control of the Senate. While Republicans appear to have taken back control of the House of Representatives, the lack of a governing majority suggests the US administration will now move into a period of legislative gridlock. A divided government means that President Biden will have to decide to either move to the centre, and try to find compromise with the GOP leadership, or try to impose policy changes for executive actions and regulatory changes.
This morning, we published our 2023 global outlook, so I thought I’d use the opportunity to share some of our key macro headlines around growth and inflation. In the document, that’s on the Barclays Private Bank’s website, there’s a more detailed breakdown for the major regions.
Global growth forecasts have, of course, tumbled as the year has progressed. The war in Ukraine, surging price pressures, and a pronounced slowdown in China have created this broad-based, synchronised slowdown. We’ve downgraded our global growth forecast for this year to 3.2%. That’s a significant reduction compared to the 4.4% estimate we proffered back at the start of the year.
It will come as no surprise that we have raised our global inflation expectations as well. We now think global consumer prices will surge 7.1% during the course of this year. We do expect price pressures will begin to ease back through the course of next year, with global consumer prices averaging 4.6% in 2023.
If we look out to next year, heightened geopolitical tensions, a tightening of financial conditions, and limited fiscal headroom will continue to weigh on growth prospects.
Further risks to output emanate from a de-anchoring of inflation expectations leading to tighter monetary policy, as the potential, of course, for the escalation of the war in Ukraine and tensions over Taiwan unnerving growth prospects as well. Markets will also be watching for the potential of a prolonged energy shock, a weaker recovery in China, and a renewed flare-up of the pandemic.
Whilst we’ve clearly become more pessimistic, I think, on global growth prospects, we should acknowledge that labour markets still remain robust, consumer and corporate balance sheets still look very healthy, excess consumer savings are still cushioning demand, and the service sector continues to have plenty of room to recover.
So, for 2023, I think, given the probability of a contraction in activity in Europe and the UK, and probably to a lesser extent in the United States, we think advanced economies will experience a relatively mild recession, with output contracting by just 0.2%. We forecast that global growth will remain positive, albeit a very weak 1.7%, as a modest recovery in China and robust growth in India offsets weakness in western economies.
I think, whilst those headline numbers may seem very discouraging, we should acknowledge that the majority of factors within our 2022 risk framework have already occurred. Therefore, with much of the bad news already incorporated into our low baseline growth forecasts for next year, the potential for further downside from tail risks has actually reduced.
In terms of inflation, we do expect price pressures to ease back over the course of the next year, partly due to technical and statistical factors, base effects, and fiscal support, particularly through the intervention of governments in energy markets, but, more fundamentally, tighter monetary policy will inevitably moderate demand. Retail inventory levels have become elevated, which should take the pressure off goods as shops are forced to aggressively discount, and global demand, we should remember, continues to rebalance away from goods into services.
We expect commodity prices to stabilise and labour, supply, and demand dynamics to improve, which will take some of the intensity out of wage inflation, and an easing of restrictions and an increase in capacity should also help to resolve some of those supply constraints.
So, where are we in terms of inflation? Well, we think that price pressures will peak in the coming months, but headline inflation is still expected to remain above the target levels through 2023 in many of the key regions, but we do think those prints will become more digestible as the year progresses.
Pressure, of course, from inflation has caused central bankers to pivot from promoting growth to curbing inflation. That policy normalisation process has certainly been early, it’s been more aggressive than we would have anticipated, but, if, as expected, inflation does moderate, we can anticipate some of the intensity out of the hiking narrative, that’s been dominating markets, to ease and that should allow officials, I think, to orchestrate a softer economic landing than the harsh recession that some economists have been predicting.
So that was the global economy and financial markets last week. In order to discuss the outlook for currency markets, I’m pleased to be joined by Bhaskar Gupta, Head of FX Distribution for Barclays Private Bank.
Bhaskar, great to have you with us today. In order to start our conversation, could you put the dramatic movements that we’ve seen in FX markets during the course of this year into some historical context?
Bhaskar Gupta (BG): Hello, Henk. Good morning, thanks for having me on the call, and a very good morning to all our listeners. Well, you are right. We have, indeed, seen currencies at levels that we wouldn’t normally associate them with. We have seen the euro below parity, all the way down to a low of the 95.50 area. On sterling, with, you know, 1.20 used to be kind of a line in the sand. Not only did that give way, we also saw some particularly panicky price action below 1.10.
Back in the end of September, the mini budget rattled the UK markets and even parity on sterling/dollar was being discussed. And similarly on the Japanese yen, you know, we saw it weaken to levels above 1.50, something we haven’t seen since as late as the early nineties, so that’s, you know, we’ve seen some drastic moves this year.
All this has been on the back of a strong dollar wave and not only the major currencies that are weakened, it’s all EM currencies, all Asian currencies, everything has weakened against the US dollar.
So, what exactly brought about this dollar strength? Well, it all started last year with some inflation, which was manageable during the course of last year, but it was something that suddenly spiralled out of control this year, and to add to that, the Russia/Ukraine crisis literally put more fuel on the fire, it put upward pressure on food and energy prices, and, thus, the US Federal Reserve had to resort to raising rates in moves of 75 basis points in order to cool the inflation down.
With the “risk-off” tone in global financial markets, you know, US Treasuries and the US dollar was the go-to safe haven and FX markets were pretty much a one-way street for the whole of this year. It was all dollar strength, unilaterally.
It pretty much kind of transcended into a self-fulfilling prophecy with even more risk aversion that led to more Treasury demand, which led to higher yields, which led to the Fed hiking more, and to more risk aversion. And it didn’t help, really, that the UK and eurozone had problems on their own domestic front. So, the eurozone’s dependence on Russian energy, and UK’s slowing growth and kind of poorly thought-out fiscal policies kept a downward pressure on these currencies.
HP: Bhaskar, central bank policy has had an important influence, as we know, on currency markets. Can you explain why this has been the case and the impact that you think it will have in the future?
BG: Well, to sum it up in one sentence, the central banks have been very busy. Their primary mandate is price stability, loosely translated as let’s say keeping inflation in check, while at the same time keeping the economy stimulated enough. So, yes, faced with spiralling inflation, the central banks have all front-loaded their rate hikes, be it the Fed, the Bank of England, European Central Bank, or even any emerging market central bank, they have all been raising rates in chunks of 50s and 75s.
We are now in a very different interest-rate environment than where we were just a year ago, and against where we have been for the whole of the last decade. Interest rates in developed economies are now at 3%, 4%, as against being close to zero and even negative in some economies a year ago.
The central banks have sometimes also been blamed. There was a couple of articles I read about the Fed being blamed for using the US dollar as a wrecking ball and being held responsible for the turmoil in financial markets. But I look at it slightly differently.
The central banks have a tightrope to walk, coupled with the fact that their actions take effect with a lag. So, to put it bluntly, they have to out-guess the impact of their own actions in future and tweak policy now. That’s a difficult task to do.
They are all just doing their job, trying to rein in inflation, that’s their primary mandate. One change that is worth noting is that the US Federal Reserve has turned from being very dovish to being quite strongly hawkish, now. Many a time they have said that they would rather over tighten than under tighten, because they see the risks lower in that scenario. And even in the last meeting, on 2nd November, they used phrases like they have a lot more room to go, it is premature to be thinking of a pause, things like that.
So, I would say, rather than creating volatility in the markets, central banks act as a backstop in times of crisis. We have seen that many times and even as recently as September in the UK, when the Bank of England had to step in to calm the blowout in the UK gilt market.
So, yeah, while we are on the subject of central banks, I would also like to mention the Bank of Japan. Typically, central banks do not directly intervene in FX markets, but some, like the Bank of Japan or the Swiss National Bank, they are known to do so when they think their currencies are at extreme levels.
So, we saw the Bank of Japan intervening in FX markets last month to prop up the value of the yen and this was, again, you know, we saw them intervening. The last time they intervened was in 1998, so this is something that needs to be kept in mind while trading currencies, while trading the yen, things like that.
HP: OK. Let’s try and understand where FX markets are going to go forward from this point on. What do you think will be the other key drivers? And perhaps one of the biggest questions that we get from our clients, have we now seen the peak in terms of the US dollar?
BG: Well, inflation has kind of dominated the headlines for the whole of this year. While we saw lower-than-expected inflation numbers in the US last week, it was still a high number, at 7.7 as the headline and 6.3 as the core inflation. While inflation can be sticky, it will continue to drive the markets. The central banks are expected to gradually reduce the size and quantum of their hikes and give the markets some time for the effects of all these rate hikes to feed through.
As we head into the holiday season, I would say numbers like retail sales, consumer spending, mortgage data, and overall GDP and growth numbers, they could take centre stage and they will be driving the currencies, going forward. While, of course, you know, the central bank commentary and their stance will be keenly watched, one more thing keenly watched will also be the China policy around their COVID restrictions, how they are going to ease it, and the kind of COVID numbers we get out of China, because that is an important factor in the global economy.
As regards whether the dollar has peaked or not, well, we are significantly off from the peak we have seen in September and October. Currencies like the euro and sterling have recovered from their extreme lows, so a softer October US CPI does support a slower Fed hike and fading upward momentum in the dollar, but a single datapoint is not really a game-changer, and further confirmation is likely needed for a more sustained US dollar correction.
Inflation momentum seems to be peaking across currencies and we could see a less profitable dollar ahead. China may be working with the path to ultimately approve a western mRNA vaccine and diminishing a very key factor that led the dollar higher. But given the tight financial conditions, it is unlikely that we see a sustained dollar sell-off from here, so as these dollar strengthening pressures abate, we could see some range-bound price action for some time.
Do keep in mind that FX volatilities are still quite high and, hence, price action will be choppy, so one has to be nimble with your trading, while trading these markets.
HP: As we have been discussing, the outlook for the global economy looks fragile. In a risk-off scenario, which currencies do you see as a safe haven?
BG: Well, the US dollar still remains the safe-haven currency of choice, and this time it’s all with the added advantage of a high yield as well. In a risk-off environment, whenever investors liquidate any asset, they now prefer to park their money in US Treasury bills or even hold the US dollar itself. The US economy is doing well, as compared to peers, and that gives comfort to the investors holding the currency.
The yen and Swiss franc are now secondary to the US dollar as a safe-haven asset. The yen, especially, has fallen out of favour from investors due to the Bank of Japan keeping a loose monetary policy and thereby deliberately keeping the yen weak. So, yes, with its attractive yields of 4% throughout the curve, the US dollar does remain the safe-haven currency of choice That’s the go-to place for all investors at this point of time.
HP: OK. Let’s finish off with how investors are looking to take advantage of the current market moves that we’ve been seeing and some of the levels that we’ve got on the screen.
BG: Well, we have been very busy and investors have been taking advantage of the strong dollar. Investors that have US portfolios, either by way of a US equity portfolio or a US bond portfolio, and which have euro or the sterling as their home currency, you know, they are sitting on 15% to 20% appreciation just because of the FX moves only.
I mean, irrespective of how their portfolio performs, the currency appreciation itself has given them these gains. So, these investors have been taking advantage of the strong US dollar and have been hedging their exposure back into euros and sterling. They have been doing it by various instruments, FX forwards, just buying outright FX options, or even risk reversals to cap their downside, in case of a reversal. So, yeah, that’s one.
Secondly, FX volatilities are quite high, and they remain elevated, so investors that are ambivalent, you know, to holding any of the major currencies, they are taking advantage of these high volatilities through to world currency investments. The yields on these world currency investments are quite attractive, given the high volatility, so that is something where we are seeing good activity as well.
HP: Well, Bhaskar, thank you for your insight today. After a strong performance for the US dollar during the course of this year it will be interesting to see if that strength does, indeed, moderate through the course of next year.
Let’s move on to the week ahead. In the UK, Thursday’s autumn statement will be closely watched for the extent of near-term fiscal consolidation, where the Chancellor is likely to pencil in significant tightening in the medium term.
Current expectations are for somewhere between £50-60 billion of consolidation. That equates to about 2.5% to 3% of GDP, which would allow him to meet, with some decent headroom, it has to be said, the measure of a declining debt-to-GDP ratio in the medium term. How much he front-loads the tax hikes and the spending cuts into next year and 2024, will certainly be relevant to market participants.
On Wednesday, in the UK we expect headline inflation in October to tick up 1.2% month-on-month, coming in at 10.3% year-on-year. That compares to 10.1% in September. The large monthly increase mainly reflects the increase in household energy bills. Although the government policy has limited that increase in energy bills relative to where they would have been under the default Ofgem cap, they are still set to increase by somewhere around about 25% in October, albeit the hit to households has been mitigated by government transfers, which are not considered in that CPI measure.
Moving on to the US, where the focus will be on retail sales and industrial production figures on Wednesday, we forecast an overall retail sales increase of 1.4% month-on-month in October, reflecting a number of tailwinds, including October’s strong increase in light-vehicle sales, higher gasoline prices, and strong sales at building materials stores in the aftermath of the recent hurricanes.
Stripping away those influences, we expect the control category to rise 0.2% month-on-month on the nominal basis, somewhat slower than September’s 0.4% month-on-month gain. We think overall industrial production will edge down 0.1% month-on-month in October following September’s 0.4% increase, with much of the softening coming from the manufacturing sector.
With that, I’d like to thank you once again for joining us. We hope that 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.
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