Markets Weekly podcast – 26 June 2023

Henk Potts (HP): Hello. It’s Monday 26^th June 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 consider the outlook for FX markets. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

The partial unwinding of the AI trade, slump in business activity in Europe and evidence of persistent inflation, and expectations of higher peak rates sucked away risk appetite last week. The second-quarter rally ground to a halt as investors weighed up the disconnect between the strong year-to-date stock performance and increasing economic headwinds and lofty valuations.

Global equities registered their biggest weekly decline since March, and there was a rotation into bonds as fears of a recession loomed large. According to Bloomberg data, investors took $5 billion from global equity funds in the week through Wednesday and added $5.4 billion to bonds. The S&P 500 fell 1.4% over the course of the last week, although it is still up 4% this month and up 5.8% through the second quarter.

European stocks wrapped up five consecutive days of losses. The STOXX 600 was down 2.9% over the course of last week. It’s now off 1% over the quarter. In government bond markets, the yield curve inversion deepened. Ten-year Treasury yields have fallen for five out of the past seven trading sessions and finished on Friday at 3.73%. Ten-year rates are nearly a full percentage point below two-year ones.

Bonds also rallied aggressively in Europe on the back of the poor PMI data on Friday. The two-year German yield is 76 basis points higher than the 10-year rate. That’s the most since 1992.

In terms of markets this morning, well, the short-lived uprising in Russia over the course of the weekend, the first military challenge to a Russian president since 1993, has called into question President Putin’s grip on power, but provided very little clarity over how the 17-month war in Ukraine will be resolved.

Therefore, the impact on markets has been somewhat limited. If you look at some of those main pressure points, currencies, commodities, equity futures, they’ve all been pretty stable in early trading. Brent crude traded marginally higher, still at $74 a barrel. Gold was up around two-tenths of 1%, at $1,925 an ounce, this morning. Week futures are up around 1%.

European bourses have opened. They’re in positive territory this morning, although only up around one-tenth of 1%.

Let’s return to the macro data. In the UK, the inflation report and the borrowing interest rate decision certainly was the big headline grabber last week. May’s UK inflation report failed to deliver the expected moderation. Headline CPI remained unchanged at 8.7% and core inflation accelerated up to 7.1% from 6.8% in April.

In terms of the breakdown, there were robust price increases in core goods and services. Meanwhile, food and energy showed some weakness.

UK inflation has moderated at a slower rate than elsewhere for a range of reasons, including the higher percentage of gas that is used for power generation. It’s also, perhaps, a reflection on the government’s policy to shield households and businesses from higher energy bills, that’s delayed some of the impact from those peak price pressures, and, you could argue, a consequence of the disruption to the supply of goods and labour as a result of Brexit and the pandemic.

UK inflation is forecast to remain above the targeted level over the course of the next 18 months. We have CPI printing at 4.2% in December and 2.8% at the end of next year. The elevated inflation report certainly increased the pressure on the Bank of England, the MPC defying the consensus forecast and hiking by half a point. On top of that, they offered a strong dose of hawkish commentary, citing the recent upside surprise in estimates for wage growth and services inflation.

Seven out of nine members voted for that 50-basis point increase. Remember, that’s the 13^th in this cycle, taking the base rate up to 5%, the highest in 15 years.

In terms of the outlook for UK rates, well, markets moved, and pretty aggressively it has to be said, now pricing in a terminal rate of 6.25% by December. We currently see increases of 50 basis points in August, followed by a 25-basis point hike in September, making the terminal rate 5.75%, but there are some upside risks, I think, to those forecasts.

Keeping with the rates story, in Switzerland the SNB, as expected, increased its policy rate by 25 basis points, up to 1.75%. It’s the fifth consecutive hike, but the smallest of this cycle. President Jordan said it’s most likely further tightening will be required as they continue to address its inflation issue, although Swiss inflation is the slowest of any advanced economy, with the SNB targeted inflation range of zero to 2%. In May, CPI was 2.2%. It’s the 15^th month it’s been above the targeted level, and rent increases may also offer some near-term upside risk.

The central bank projects inflation will average 2.2% this year and next, and then 2.1% in 2025. The SNB has been hiking rates and intervening in currency markets in an effort to combat inflation. This has supported the Swiss franc but has started to impact exports. The Swiss economy is expected to continue to benefit from positive private consumption. The labour market remains robust. The Federal Council expects economic growth will be below average this year, at 1.1%, and then show some signs of recovery in 2024, with growth of 1.5% as external demand begins to improve.

In terms of Europe, well, as we’ve been talking about, data showed that business activity continues to decline. The flash eurozone composite PMI output index fell to 50.3, only marginally above that contraction line, and the lowest in five months. A 2.5-point drop in the index is the largest recorded in a year. New orders fell for the first time since January, employment growth slowed and future output expectations also deteriorated.

In terms of the breakdown, well, manufacturing remains the main area of weakness, with factory output falling for a third straight month and at its fastest pace since October. Meanwhile, spending on services lost momentum. The service sector, actually, grew at its slowest rate since January. We think the figures add to the evidence of the fragile economic backdrop that continues in Europe and the ongoing risks to the region could drop back into recession.

Finishing off in the US, where there were further signs that the housing market is stabilising. Housing starts rose 21.7% in May. Building permits returned back to positive territory, with a 5.2% increase. US house prices have come under pressure, as mortgage rates surged to 21-year highs. The Case-Shiller Home Price Index declined for seven consecutive months before returning to growth back in February. The rebound accelerated in March with a 1.3% month-on-month increase, although the national composite for home prices is still 3.6% below the peak we saw in June 2022.

US mortgage rates have started to stabilise and the lack of inventory, I think, continues to support prices. However, economic uncertainty, mortgage rates above 6% and tighter mortgage financing will likely be headwinds for the sector.

So, that was the global economy and financial markets last week. In order to consider opportunities in FX 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 this morning. First of all, let me ask, have we seen any reaction to the attempted coup in Russia over the course of the weekend? What would you expect form further domestic disruption in Russia or, indeed, an escalation of the war in Ukraine?

Bhaskar Gupta (BG): Hello, Henk. Thanks for having me on the podcast. It’s always a pleasure.

Yes, the events in Russia were quite worrisome for the entire world, and this has always been a risk ever since this war broke out, you know. It’s one of those known unknowns. What happens if there’s an internal dispute within Russia, how that pans out, how that impacts the world is quite unknown. So, if it would not have been resolved in a matter of hours, like it did, on Saturday itself, so the world did breathe a sigh of relief. But if it did not happen, then there would have been a massive move, a massive frenzy to buying safe-haven assets this morning.

So, we would have seen the yen strengthen, we would have seen the Swiss franc and the US dollar strengthen. We would have seen impacts in gold, in US Treasuries and, obviously equities would have fallen. But, thankfully, given the way it was resolved and neutralised quite swiftly, this did not happen. But then, the threat still stays and, obviously, we are talking about a nuclear-powered state at this point of time. So, the impacts of these actions will have an effect on the entire world and not just these two warring parties.

So, thankfully, that did not happen. Markets are quite, you know, stable and we can carry on from here.

HP: OK, great. Thanks for sharing those early thoughts. Let’s look a little bit more broadly about what’s been happening in terms of FX markets over the course of the past couple of months. Can you give us a short summary of how currencies have been trading and where the main areas of interest have been?

BG: Yeah, so what’s been happening? Well, things have been rather range-bound for a while now. Both cable and euro/dollar have been trading in tight ranges. Cable, you know, 1.24 to 1.28, and the euro in the 1.06 to 1.10 range. They are both unable to break out on either side. It’s not that this is completely unexpected. In the lag of any big trigger, that’s what one would expect.

Things that could have, potentially, moved currencies and other assets, for example, the US regional bank crisis in March, or even the more recently the US debt-ceiling debate, they’ve all been resolved in a very timely manner. So, while there is no underlying narrative at this point of time, data is taking on a more significant role, and each economic release does have the potential to move the markets, albeit only slightly, still within the broad ranges.

Like we saw last Friday, when the weak PMI numbers dented both the sterling and the euro highs, and in the case of sterling it was in spite of a very hawkish 50-basis point hike from the Bank of England only a day before.

So, yes, all in all, things are in a holding pattern until something kicks off. And I might add, markets do have a tendency to stir things up from all sorts of unexpected quarters. So, yes, while things are quiet for now, one should not let their guard down.

HP: Well, we have been discussing that 50-basis point hike from the Bank of England last week which, as you say, certainly surprised economists. Markets are now pricing in a terminal rate above 6%. Does that give the pound sterling an advantage?

BG: Yes, the Bank of England stance, and the mere fact that sterling is heading towards having higher interest rates than its peers, does give it an inherent carry advantage, which does work in its favour. But then, as we all know, there are so many other things that impact the FX rates as well.

Take last Thursday’s rate hike itself, on a given day, when central banks hiked more than expected, this would have resulted in a nice tailwind for a currency. But the implicit assumption that the Bank of England is steering the UK economy towards a slowdown or a recession, and given the fact that sterling was itself trading at relatively high levels, traders chose to book profit on their longs and the recession argument brought the currency lower.

And then, again, on Friday we saw it weaker on the back of PMI numbers. So, yes, while the Bank of England hikes do give an uplift to the pound, it wouldn’t be a straight-line appreciation for the currency.

HP: Bhaskar, what about the other central banks? How are future rate expectations filtering into the current currency forecasts?

BG: The other central banks? The Fed paused in June, but clearly indicated they were not done with hiking. They just took a pause to assess the economy further and decide on, you know, how much more is needed. And it’s the right thing to do. You need to give time for interest rate hikes to feed through into the economy. So that was the right decision from them. Markets are pricing in probably one more rate hike from the Fed.

Then, in a similar vein, two more rate hikes are expected from the European Central Bank, pricing in a terminal rate of 4%. So, overall, we do expect the US dollar to be slightly weaker in the second half of the year, and probably sterling and euro to trade slightly stronger from their current levels today.

HP: OK. Where do you see the next big move and how are investors playing the current landscape?

BG: Well, the Japanese yen stands out as a candidate for a big impending move, a) it has steadily weakened from, let’s say, about 1.35 to 1.43 over the last few weeks, and if it weakens further, it will be approaching territory where the Bank of Japan tends to intervene. And for the yen, the focus will now turn to the Bank of Japan to start the groundwork to introduce tweaks to their yield curve control policies. So, the Japanese yen, I would say, is the one to watch where it can have a big move.

In terms of flow, we see a lot of renewed interest in dual-currency investments (DCIs). Investors that are indifferent to holding either of the major currencies are using DCIs as a nice yield-enhancing tool with money market deposit rates themselves being very high and reasonable FX volatilities mean all DCIs are quite attractive.

And we’re also seeing a lot of sterling/euro hedging going on. Investors that have a sterling asset, say in the form of cash balances or fixed deposits, and have euro liabilities, it could be either euro mortgages or overdrafts, they are taking advantage of the current spike in sterling/euro and are hedging their exposure.

HP: Well, thank you, Bhaskar, for your insights today. We know that listeners are always interested in understanding the drivers of FX markets, the current forecasts and potential opportunities.

Let’s move on to the week ahead, where the focus will be on Friday’s eurozone inflation print, where we expect CPI to moderate to 5.6% in June, down half a percentage point from the May reading, helped by base effects and disinflation in non-energy goods, but services price momentum is expected to have reaccelerated, driven by firm consumer demand for discretionary services amid robust labour markets, which has been supporting spending.

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