Markets Weekly podcast – 11 September 2023

Henk Potts (HP): Hello. It’s Monday, 11th September 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 at 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.

Now, deteriorating European and Chinese economic data, rising energy prices and nervousness about the upcoming interest rate decisions created a difficult backdrop for investors last week. Equities remained under pressure.

In Europe, the STOXX 600, which fell 2.7% we should remember in August, has made a poor start to September and has fallen seven out of the past eight consecutive trading sessions, representing the longest losing streak since 2018. It was down 0.8% last week.

On Wall Street, it’s been a similar picture. The S&P 500 was down 1.3% last week, although the benchmark index is still up an impressive 16% year to date. In commodities, oil traded above $90 a barrel for the first time since November, it is now up around about 13% year to date, as Saudi Arabia extended production cuts by a longer-than-expected three months in a move that will keep production levels at multi-year lows of around nine-million barrels per day.

Russia also said it would curb 300,000 barrels a day of exports through year-end. Despite concerns around the economic outlook, crude prices continued to be supported by the supply and demand dynamic.

On the demand side, concerns around the slowdown in activity in China and Europe have been offset by resilient activity in the US and hopes of a stabilisation in the industrial sector.

Now, the International Energy Agency continues to predict strong demand growth during the course of this year. It forecasts that global oil demand will increase by 2.2 million barrels per day, up to a record 102.1 million barrels per day in 2023.

Looking at the supply side, along with the production cuts, a number of Opec producers have been struggling to meet their output targets. US supply growth has been slower than expected and inventories are being drawn down, although we should mention that Iran is ramping up production to around three million barrels per day and Venezuelan output is showing some signs of recovery.

We continue to see opportunities in the energy sector due to the rise in oil prices. Energy stock prices have lagged their relationship with earnings, we see attractive valuations, sector trades on a significant discount to the market and history, and, we should remember, offers a superior dividend yield. It can also be considered as a hedge against inflation and geopolitical risk.

Moving on to currencies, where the dollar rose to a six-month high as US economic data continues to outperform its European and Chinese counterparts, and the hawkish Fed suggests a further hike this year is on the cards, and there are growing expectations that rate cuts in 2024 could come later than some market participants have been expecting.

The Bloomberg Dollar Spot Index has now risen for eight consecutive weeks, and we’ll go into greater detail on that topic in just a few minutes’ time.

Keeping on the macro front, the eurozone managed to grow in the second quarter, but only by the barest of margins as far-weaker-than-expected exports resulted in a significant downward revision to growth. GDP grew at just one-tenth of 1% in the three months through June. That compares to the original estimate of three-tenths of 1%.

We expect eurozone activity to remain weak in the second half of this year, and constrained through the course of 2024, as rate hikes weigh on consumption and investment and external demand remains under pressure. We do know the consumer has been under a significant amount of pressure in the eurozone. Retail sales have slumped as households have tightened their belts in reaction to the squeeze on disposable income. They’ve also been saving more of their money.

Personal consumption looks set to remain under pressure over the course of the next year as the lag effect from eurozone rate increases continues to catch up with consumers. Meanwhile, Europe’s capital-intensive industrial sector continues to struggle.

If you look at the manufacturing purchasing managers’ index, it fell to 42.7 in July, representing the 13th consecutive month in which it’s been below the 50-point, which separates expansion from contraction. The reading shows that manufacturing activity is now back to its lowest level since the pandemic in May 2020.

In terms of eurozone growth, we don’t expect to see that deep recession that was feared at the start of the year, but we still think it will face significant economic challenges and uninspiring growth over the course of the next couple of years. We’ve got half of 1% pencilled in for this year, and six-tenths of 1% pencilled in for 2024.

So, that was the global economy and financial markets last week. In order to understand the key drivers that are likely to be moving FX markets in the coming year, 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. As we know, we’ve been through a rather quiet summer this year, it has to be said, from an FX perspective, after a significantly volatile previous 12 to 18 months. Can you tell us what’s been going on in FX markets?

Bhaskar Gupta (BG): Sure, Henk. And thanks for having me on the podcast, it’s always a pleasure. As you rightly say, FX markets have definitely been subdued over the past couple of months. The majors have been very range-bound, you know, cable in a 1.25 to 1.30 range and the euro in a 1.07 to 1.11 range. Intraday volatility has been at the lower end of the spectrum and these major currency pairs have clearly lagged a trend or a direction.

This follows on from 2022 and early 2023, when the world was hit by multiple shocks simultaneously, but now things seem to have settled down. Inflation is receding in most economies, central banks are no longer on an aggressive tightening path and there is less uncertainty overall.

Summer months typically see less flow and lighter positioning from all participants, and trading has been lacklustre over the last few months. But, having said that, and while the majors have been rangy, we did see some directional moves in the yen, which has weakened due to a still dovish Bank of Japan and the ‘carry trade’ coming into play. And we’ve also seen the Aussie and the Kiwi weaker due to weakness in China and these currencies being correlated strongly with the Chinese economy.

HP: Bhaskar, we know that central banks obviously play a big role in all markets, as we’ve been discussing already this morning. Can you tell us what is expected from them going forward and how that plays out in terms of FX markets?

BG: Yes, well central banks have so far managed to raise rates sharply and bring inflation lower without breaking the economy. As a result of this tightening and even lower energy prices from the peak of 2022, inflation expectations have slid from the multi-year highs seen last year and are now much lower. And even expectations for a recession, albeit even if only a technical one, keep getting pushed out quarter by quarter. 

So, central banks are now in a place where they don’t necessarily need to raise rates further, and just let the previous rate hikes seep into the economy and let them do their job. Of course, they can’t let their guard down in any way and we’ll have to keep a very close eye on all the economic data and tweak policy as needed.

In terms of what is currently priced in from the major central banks, well, the Fed is expected to hold rates at the current 5.5% at least until summer next year. At best, they might raise rates one last 25 basis points in the November meeting, but that will be very much data dependent. 

As regards the Bank of England, Governor Andrew Bailey, speaking to the Treasury Committee last week, noted that data is signalling a fall in inflation and that they are much nearer the top of the cycle on interest rates. So, we expect one final hike from the central bank at the next meeting on 21st September. 

And finally, as regards the ECB, they seem generally uncertain as to what to do with the higher-than-they-would-like inflation coupled with the woeful activity data. We expect the ECB to keep rates unchanged and maintain a tightening bias through hawkish talk, as they have been doing recently. All in all, higher-for-longer will be the mantra for some time across all central banks, and rate cuts appear rather distant well into the third or fourth quarter of next year.

HP: OK. What do you expect going into year-end? Will this equilibrium hold, or can we expect more volatility? How do you think FX markets will play out?

BG: Well, the current landscape is very interesting. The dollar is once again forming into a cross-asset barometer for the soft- versus hard-landing market dynamic. Soft growth out of China and Europe, coupled with the high oil prices, have triggered a recent dollar rally, as you mention, which is coincidental with a broader tightening in financial conditions across equities and bonds.

However, we are now looking ahead into, if I may say, a bifurcated FX universe. Moderation in US data can offer a level of relief in the FX space, mostly among the high-yielding currencies. But the growth risks from overly hawkish central banks and disinflating economies implies more depreciation pressure for cyclical currencies, for example, the Chinese yuan and other non-Japan Asian currencies. And given the inherent risks in domestic economies, we see a lack of meaningful upside for the pound sterling or the euro and see them trading sideways.

Lastly, we continue to view the yen as the best growth insurance and, coupled with the fact that it is not trading miles away from a Bank of Japan intervention zone, it probably has more upside than downside.

HP: OK. Let’s get a little bit more practical. How can investors take advantage of these FX markets. How should they be positioned and what are the key risks to watch out for?

BG: Well, there are many opportunities that investors can take advantage of. Dual-currency investments (DCIs) stand out. Investors that are indifferent to holding either of the major currencies can use DCIs as a nice yield-enhancing tool. With money-market deposit rates themselves being high, the yield on these DCIs is quite attractive.

Another thing we need to note is that volatilities are quite low at this time, so that makes currency hedging by way of options cheaper. These periods of low volatility don’t tend to last long, and markets have a way of erupting on something or the other, so investors would be prudent to hedge their currency risks through FX options. It could be through just either buying vanilla options or outright or through simple structures like collars. 

In terms of risks, I would say with real rates rising, both via higher interest rates and moderating inflation, and growth continuing to soften, the chances of an accident are rising again. Specifically, we can imagine a situation in which growth data softens, inflation comes in stickier, for example, due to higher energy prices, and the Fed leans more hawkish.

There is a non-trivial possibility that that could trigger intermittent bouts of dollar strength. So, investors need to stay alert, either to control their risk or to take advantage of such spikes.

HP: Well, thank you, Bhaskar, for your insights today. We know that currency markets are always of interest to our listeners, so your clarity on the key driving factors with informed forecasts are greatly appreciated.

Let’s move on to the week ahead where the focus will be on the European Central Bank meeting and the August US inflation print. So, we were just hearing that the European Central Bank interest rate decision is expected to be a close call. If you look at market pricing, it’s round about a 40% chance that they will hike on Thursday. But we think, on the balance of probabilities, the central bank is likely to keep its policy rates unchanged.

In terms of currencies, as we were just discussing, we expect the ECB to maintain its tightening bias, thereby giving it future optionality. Beyond that, we look for the staff macroeconomic projection to show a worsening of the medium-term growth prospects and a slightly lower headline rate in core inflation from 2024.

In terms of the rates outlook beyond that, well, a period of stagnation and declining inflation should encourage the European Central Bank to keep rates on hold, not only this week but until the middle of next year, suggesting July’s hike was actually the last in terms of this cycle.

Rates may then fall by as much as a percentage point through the second half of 2024, taking rates back to a more neutral 2.75% by the end of next year in Europe.

Finishing off with US inflation, we expect the figures to show a reacceleration of price pressures in August due to rising energy prices. US retail gasoline prices rose 6.7% in August. Therefore, we look for headline CPI growth of six-tenths of 1% month on month, 3.7% year on year. The forecast is that core inflation firmed by two-tenths of 1% month on month, and 4.3% year on year.

Within the core measure, we expect to see a decline in used-car prices, pushing core goods into deeper deflation, but firmer air fares and hotel prices helping to drive services inflation higher.

In terms of the outlook for inflation, we see headline CPI printing at 3.3% in December this year and then decelerating to 2.5% in December 2024, which, I think, is consistent with a view that maybe we’ll see one more additional rate hike coming through in terms of November.

And 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.