Major Markets Global Overview

From Inflation to Recession: New Risks Abound

August 31, 2022
High food and energy prices continue to squeeze households globally. Aggressive monetary policy responses and shrinking real incomes have increased global recession risks. Indeed, more and more signs of recession are piling up.

High food and energy prices continue to squeeze households globally. Aggressive monetary policy responses and shrinking real incomes have increased global recession risks. These and other signs of recession continue to pile up.

German and Italian composite Purchasing Managers Index (PMI) readings fell below 50, while the Bank of England forecasts a U.K. recession by Q4. China is facing recession risk after GDP grew only 0.4% y/y in Q2, while COVID Zero lockdowns and drought are adding to the headwinds on the mainland.

In the U.S., the signs are mixed; GDP has fallen q/q for two straight quarters, yet nearly a million jobs were added in the past two months and consumption remains strong. While we believe the U.S. will outperform the rest of the word in H2, there is no denying that recession risks here are tangible. 

Key Investment Calls

We stress that there is currently a lot of noise even as markets remain thin during the summer months. We are likely to continue seeing violent moves in the markets in the coming weeks as markets continue to struggle to find a reliable and sustainable macro outlook to trade on. Recession? Soft landing? Tightening? Eventual easing? These questions remain unanswered, not just for the U.S. but globally. We will not know the truth for months, if not quarters.

In this current environment, the dollar should continue to outperform vs. EUR, GBP, and JPY due to rising 2-year interest rate differentials. The uncertain equity outlook remains due to global recession risks. Global bond markets are likely to continue rallying as inflation peaks and growth slows; curve flattening in the U.S. is likely to continue.


This graph represents the 2-year yield differentials between the U.S. and Japan, the U.S. and Germany, and the U.S. and the U.K. from 2018 to 2022. According to the data, The United Kingdom currently is at 106 basis points, Germany is at 264 basis points, and Japan is at 332 basis points.

What We’ve Got Here is a Failure to Communicate

What we have seen since the July 26-27 FOMC is a master class in central bank communication. The Fed hiked 75 bp, as expected, but the market interpreted Powell’s press conference as signaling a dovish pivot. We disagreed with that interpretation and were happy to see that the Fed did too. The bank was clearly unhappy with the market’s dovish take and has gone all out in a unified and credible manner to convey this. Fed officials have made it clear that there is a long way to go in terms of getting inflation down and that interest rates will be higher for longer. We expect this communication effort to continue for the foreseeable future.

There are too many official comments to list here, but the most noteworthy is the evolution of uber-dove Kashkari into uber-hawk. He recently noted that the July CPI data did not change his expected rate path, though he was happy to see inflation surprise to the downside. Kashkari said he wants the Fed Funds rate at 3.9% by year-end and 4.4% by end-2023. He stressed that the Fed is far from declaring victory over inflation and stressed that recession “will not deter me” from getting to the 2% target. It's amazing how far Kashkari has swung from uber-dove to uber-hawk. The Fed's communication strategy remains intact. The only question is when will the markets start listening?

We expected no surprises at the August 25-27 Jackson Hole Symposium. In the past, this event has been used to unveil new measures or set the table for such moves. With nearly a month to go before the September 20-21 meeting and the economic outlook still rapidly evolving, we did not expect the Fed to pre-commit to any policy measures at Jackson Hole. Rather, the current hawkish Fed messaging was maintained. 
 


Date CPI Core CPI Core PCE Fed Funds Upper Bound PCE
8/22/2022       2.5  
7/31/2022 8.52 5.91   2.5  
6/30/2022 9.06 5.92 4.79 1.75 6.76
5/31/2022 8.58 6.02 4.67 1 6.32
4/30/2022 8.26 6.16 4.91 0.5 6.27
3/31/2022 8.54 6.47 5.22 0.5 6.64
2/28/2022 7.87 6.41 5.31 0.25 6.27
1/31/2022 7.48 6.02 5.13 0.25 6
12/31/2021 7.04 5.45 4.89 0.25 5.78
11/30/2021 6.81 4.93 4.69 0.25 5.65
10/31/2021 6.22 4.56 4.19 0.25 5.06
9/30/2021 5.39 4.03 3.7 0.25 4.44
8/31/2021 5.25 4 3.6 0.25 4.24
7/31/2021 5.37 4.27 3.6 0.25 4.16
6/30/2021 5.39 4.47 3.59 0.25 4.03
5/31/2021 4.99 3.8 3.46 0.25 3.97
4/30/2021 4.16 2.96 3.08 0.25 3.58
3/31/2021 2.62 1.65 1.97 0.25 2.45
2/28/2021 1.68 1.28 1.49 0.25 1.63
1/31/2021 1.4 1.41 1.51 0.25 1.41
12/31/2020 1.36 1.62 1.48 0.25 1.29
11/30/2020 1.17 1.65 1.38 0.25 1.11
10/31/2020 1.18 1.61 1.42 0.25 1.17
9/30/2020 1.37 1.71 1.57 0.25 1.38
8/31/2020 1.31 1.74 1.5 0.25 1.3
7/31/2020 0.99 1.57 1.3 0.25 1.04
6/30/2020 0.65 1.19 1.13 0.25 0.91
5/31/2020 0.12 1.22 1 0.25 0.51
4/30/2020 0.33 1.43 0.91 0.25 0.41
3/31/2020 1.54 2.09 1.7 0.25 1.34
2/29/2020 2.33 2.36 1.91 1.75 1.87
1/31/2020 2.49 2.26 1.78 1.75 1.9
12/31/2019 2.29 2.26 1.64 1.75 1.65
11/30/2019 2.05 2.32 1.57 1.75 1.42
10/31/2019 1.76 2.31 1.72 1.75 1.41
9/30/2019 1.71 2.36 1.71 2 1.38
8/31/2019 1.75 2.39 1.85 2.25 1.51
7/31/2019 1.81 2.21 1.73 2.25 1.52
6/30/2019 1.65 2.13 1.72 2.5 1.46
5/31/2019 1.79 1.99 1.61 2.5 1.5
4/30/2019 2 2.06 1.69 2.5 1.62
3/31/2019 1.86 2.04 1.56 2.5 1.47
2/28/2019 1.52 2.08 1.67 2.5 1.36
1/31/2019 1.55 2.15 1.83 2.5 1.47
12/31/2018 1.91 2.18 2.06 2.5 1.86
11/30/2018 2.18 2.21 2.06 2.25 2.01
10/31/2018 2.52 2.14 1.93 2.25 2.11
9/30/2018 2.28 2.17 2.04 2.25 2.07
8/31/2018 2.7 2.2 2.03 2 2.28
7/31/2018 2.95 2.35 2.13 2 2.44
6/30/2018 2.87 2.26 2.07 2 2.38
5/31/2018 2.8 2.24 2.11 1.75 2.37
4/30/2018 2.46 2.14 2.01 1.75 2.15
3/31/2018 2.36 2.12 2.08 1.75 2.18
2/28/2018 2.21 1.85 1.78 1.5 1.96
1/31/2018 2.07 1.82 1.73 1.5 1.84
12/31/2017 2.11 1.78 1.72 1.5 1.88
11/30/2017 2.2 1.71 1.7 1.25 1.96
10/31/2017 2.04 1.77 1.69 1.25 1.82
9/30/2017 2.23 1.69 1.58 1.25 1.88
8/31/2017 1.94 1.68 1.5 1.25 1.63
7/31/2017 1.73 1.69 1.59 1.25 1.56
6/30/2017 1.63 1.7 1.7 1.25 1.58
5/31/2017 1.87 1.73 1.65 1 1.66
4/30/2017 2.2 1.88 1.7 1 1.84
3/31/2017 2.38 2 1.69 1 1.9
2/28/2017 2.74 2.22 1.89 0.75 2.19
1/31/2017 2.5 2.27 1.9 0.75 2.04
12/31/2016 2.07 2.2 1.83 0.75 1.71
11/30/2016 1.69 2.11 1.76 0.5 1.44
10/31/2016 1.64 2.14 1.82 0.5 1.46
9/30/2016 1.46 2.21 1.68 0.5 1.23
8/31/2016 1.06 2.32 1.7 0.5 0.9
7/31/2016 0.83 2.19 1.58 0.5 0.75
6/30/2016 1 2.24 1.5 0.5 0.79
5/31/2016 1.02 2.24 1.5 0.5 0.8
4/30/2016 1.13 2.15 1.47 0.5 0.89
3/31/2016 0.85 2.19 1.38 0.5 0.63
2/29/2016 1.02 2.33 1.39 0.5 0.59
1/31/2016 1.37 2.21 1.34 0.5 0.82
12/31/2015 0.73 2.1 1.13 0.5 0.3
11/30/2015 0.5 2.02 1.16 0.25 0.23
10/31/2015 0.17 1.91 1.16 0.25 0.09
9/30/2015 -0.04 1.89 1.23 0.25 0.08
8/31/2015 0.2 1.83 1.23 0.25 0.26
7/31/2015 0.17 1.8 1.19 0.25 0.24
6/30/2015 0.12 1.76 1.29 0.25 0.31
5/31/2015 -0.04 1.72 1.28 0.25 0.23
4/30/2015 -0.2 1.81 1.34 0.25 0.16
3/31/2015 -0.07 1.75 1.36 0.25 0.28
2/28/2015 -0.03 1.7 1.4 0.25 0.29
1/31/2015 -0.09 1.65 1.36   0.18

Trouble With the Curve

Markets are paying close attention to the shape of the U.S. yield curve. The 2- to 10-year curve inverted back in early July and currently stands at -39 bp. It has not been this inverted since 2000. However, several San Francisco Fed studies suggest that the 3-month to 10-year curve is the best at predicting U.S. recessions. At 28 bp, it is the flattest since March 2020; the speed of the flattening has been astounding, as it peaked near 231 bp in May and was still as high as 185 bp in June and 120 bp in early July before plunging to current levels. Inversion of the 3-month to 10-year would signal recession is likely over the following 12 months.

Of note, when this curve peaked at 231 bp, the 2- to 10-year curve was already trading near 40 bp before inverting two months later. That unprecedented divergence between the 3-month and 10-year curve and the 2- to 10-year curve has narrowed significantly and as a result, the risks of recession are clearly rising. The New York Fed estimates that the risk of a recession within 12 months at around 18% in July, up from only 4% in May and 6% in June and the highest since October 2021. With the curve getting even flatter in August, the odds will rise further. Stay tuned.
 


This graph represents the U.S. yield curve as a percentage from the years 2018 to 2022. According to the graph, the green line is the 5-10 year percentage point of -0.12, the blue 2-30 year is -.034, the yellow 2-10 year with -0.39, red 1-10 year of -0.38, and black 3 month-10 year being 0.28, all as of 2022, and expressed as percents.

Stalemate in Ukraine?

One of the biggest surprises of the Ukraine crisis is how effectively it has stood up to the invading forces. What was initially thought to be a cakewalk has turned into a stalemate, as Russia has been unable to extend its control beyond the eastern Donbas region. Another round of sanctions on Russia was recently announced.

On the other hand, Europe is facing natural gas shortages in the coming months as Russia pipeline flows are running at only 20% of normal. This is preventing Europe from building winter stockpiles. It is worth noting that other commodity prices are at or below pre-invasion levels, which bodes well for headline inflation readings in H2. Notably, grain shipments from Ukraine have resumed. Lastly, Finland and Sweden have formally applied for NATO membership; nearly half its 30 members have already approved entry, including the U.S.

Russia’s invasion has done exactly what it wanted to prevent, provoking greater unity in the West in opposition.
 


Date Brent Oil Natural Gas Corn Wheat
8/22/2022 97 212 91 83
8/19/2022 98 204 90 81
8/18/2022 97 201 89 79
8/17/2022 95 202 88 82
8/16/2022 93 204 88 85
8/15/2022 96 191 90 86
8/12/2022 99 192 92 87
8/11/2022 101 194 91 88
8/10/2022 98 180 89 86
8/9/2022 97 171 89 84
8/8/2022 98 166 88 84
8/5/2022 96 177 88 84
8/4/2022 95 178 87 85
8/3/2022 98 181 85 82
8/2/2022 101 169 85 84
8/1/2022 101 181 87 86
7/29/2022 111 180 89 87
7/28/2022 108 178 88 88
7/27/2022 108 190 86 85
7/26/2022 105 197 86 87
7/25/2022 106 191 83 83
7/22/2022 104 182 81 82
7/21/2022 105 174 83 87
7/20/2022 108 175 85 88
7/19/2022 108 159 86 88
7/18/2022 107 164 88 88
7/15/2022 102 154 87 84
7/14/2022 100 144 100 86
7/13/2022 100 146 106 86
7/12/2022 100 135 105 87
7/11/2022 108 141 112 91
7/8/2022 108 132 112 95
7/7/2022 106 138 107 89
7/6/2022 102 121 107 86
7/5/2022 104 121 106 86
7/4/2022 115      
7/1/2022 113 125 109 90
6/30/2022 116 119 107 94
6/29/2022 117 142 111 99
6/28/2022 119 143 109 99
6/27/2022 116 142 107 98
6/24/2022 114 136 108 100
6/23/2022 111 137 107 101
6/22/2022 113 150 111 105
6/21/2022 116 149 109 105
6/20/2022 115      
6/17/2022 114 152 113 112
6/16/2022 121 163 113 116
6/15/2022 120 162 111 113
6/14/2022 122 157 111 113
6/13/2022 123 188 111 116
6/10/2022 123 194 111 116
6/9/2022 124 196 111 116
6/8/2022 125 190 110 116
6/7/2022 122 203 109 116
6/6/2022 121 204 107 118
6/3/2022 121 187 105 112
6/2/2022 119 186 105 114
6/1/2022 117 190 105 112
5/31/2022 124 178 108 117
5/30/2022 123      
5/27/2022 121 191 112 125
5/26/2022 118 195 110 123
5/25/2022 115 196 111 124
5/24/2022 115 193 111 125
5/23/2022 114 191 113 129
5/20/2022 114 177 112 126
5/19/2022 113 182 113 130
5/18/2022 110 183 112 133
5/17/2022 113 182 115 138
5/16/2022 115 174 116 135
5/13/2022 113 168 114 126
5/12/2022 108 169 117 127
5/11/2022 109 167 115 120
5/10/2022 103 162 113 117
5/9/2022 107 154 113 117
5/6/2022 113 176 114 118
5/5/2022 112 192 116 118
5/4/2022 111 184 115 115
5/3/2022 106 174 115 112
5/2/2022 109 164 117 113
4/29/2022 110 159 118 113
4/28/2022 109 151 117 116
4/27/2022 106 159 117 117
4/26/2022 106 150 116 117
4/25/2022 103 146 115 115
4/22/2022 108 143 114 115
4/21/2022 109 152 115 115
4/20/2022 108 152 117 117
4/19/2022 108 157 116 119
4/18/2022 114 171 117 121
4/14/2022 113 160 114 118
4/13/2022 110 153 113 120
4/12/2022 106 146 112 119
4/11/2022 99 145 110 117
4/8/2022 104 137 111 114
4/7/2022 102 139 109 110
4/6/2022 102 132 109 112
4/5/2022 108 132 109 113
4/4/2022 109 125 108 109
4/1/2022 105 125 106 106
3/31/2022 109 124 108 109
3/30/2022 115 123 106 111
3/29/2022 111 117 104 110
3/28/2022 114 121 108 114
3/25/2022 122 122 108 119
3/24/2022 120 118 108 117
3/23/2022 123 115 109 119
3/22/2022 117 114 108 121
3/21/2022 117 107 109 121
3/18/2022 109 106 107 115
3/17/2022 108 109 109 119
3/16/2022 99 104 105 115
3/15/2022 101 100 109 125
3/14/2022 108 102 105 118
3/11/2022 114 103 110 118
3/10/2022 110 101 109 116
3/9/2022 112 99 106 130
3/8/2022 129 99 109 137
3/7/2022 124 106 108 154
3/4/2022 119 110 109 146
3/3/2022 111 103 108 139
3/2/2022 114 104 106 114
3/1/2022 106 100 106 108
2/28/2022 102 96 100 100
2/25/2022 99 98 95 91
2/24/2022 100 100 100 100

ECB Hawks Win….For Now

The ECB started the tightening cycle with a 50 bp hike July 21. This was its first hike since 2011 and the largest since 2000. Madame Lagarde and the doves had been penciling in a 25 bp move but the deteriorating inflation outlook meant that the hawks prevailed. In mid-June, the swaps market was pricing in a peak deposit rate near 2.5%, which amounted to 300 bp of tightening from -0.5%. The hawkish narrative was prevailing and so markets were preparing for an aggressive EB tightening cycle.
 


Date CPI (R1) Core CPI (R1) Main Refi Rate (R1) Depo Rate (R1) PPI (L1)
8/19/2022     0.5 0  
7/31/2022 8.9 4 0.5 0  
6/30/2022 8.6 3.7 0 -0.5 35.8
5/31/2022 8.1 3.8 0 -0.5 36.2
4/30/2022 7.4 3.5 0 -0.5 37.3
3/31/2022 7.4 3 0 -0.5 36.9
2/28/2022 5.9 2.7 0 -0.5 31.5
1/31/2022 5.1 2.3 0 -0.5 30.8
12/31/2021 5 2.6 0 -0.5 26.4
11/30/2021 4.9 2.6 0 -0.5 23.7
10/31/2021 4.1 2 0 -0.5 21.9
9/30/2021 3.4 1.9 0 -0.5 16.1
8/31/2021 3 1.6 0 -0.5 13.5
7/31/2021 2.2 0.7 0 -0.5 12.4
6/30/2021 1.9 0.9 0 -0.5 10.3
5/31/2021 2 1 0 -0.5 9.6
4/30/2021 1.6 0.7 0 -0.5 7.6
3/31/2021 1.3 0.9 0 -0.5 4.4
2/28/2021 0.9 1.1 0 -0.5 1.5
1/31/2021 0.9 1.4 0 -0.5 0.4
12/31/2020 -0.3 0.2 0 -0.5 -1.1
11/30/2020 -0.3 0.2 0 -0.5 -2
10/31/2020 -0.3 0.2 0 -0.5 -2
9/30/2020 -0.3 0.2 0 -0.5 -2.3
8/31/2020 -0.2 0.4 0 -0.5 -2.6
7/31/2020 0.4 1.2 0 -0.5 -3.2
6/30/2020 0.3 0.8 0 -0.5 -3.7
5/31/2020 0.1 0.9 0 -0.5 -5
4/30/2020 0.3 0.9 0 -0.5 -4.6
3/31/2020 0.7 1 0 -0.5 -2.8
2/29/2020 1.2 1.2 0 -0.5 -1.4
1/31/2020 1.4 1.1 0 -0.5 -0.8
12/31/2019 1.3 1.3 0 -0.5 -0.7
11/30/2019 1 1.3 0 -0.5 -1.4
10/31/2019 0.7 1.1 0 -0.5 -2
9/30/2019 0.8 1 0 -0.5 -1.2
8/31/2019 1 0.9 0 -0.4 -0.9
7/31/2019 1 0.9 0 -0.4 0.1
6/30/2019 1.3 1.1 0 -0.4 0.7
5/31/2019 1.2 0.8 0 -0.4 1.6
4/30/2019 1.7 1.3 0 -0.4 2.6
3/31/2019 1.4 0.8 0 -0.4 2.8
2/28/2019 1.5 1 0 -0.4 2.9
1/31/2019 1.4 1.1 0 -0.4 3
12/31/2018 1.5 0.9 0 -0.4 3.1
11/30/2018 1.9 0.9 0 -0.4 4.1
10/31/2018 2.3 1.2 0 -0.4 5
9/30/2018 2.1 1 0 -0.4 4.6
8/31/2018 2.1 1 0 -0.4 4.5
7/31/2018 2.2 1.1 0 -0.4 4.3
6/30/2018 2 1 0 -0.4 3.6
5/31/2018 2 1.2 0 -0.4 3
4/30/2018 1.2 0.7 0 -0.4 1.8
3/31/2018 1.4 1.1 0 -0.4 2
2/28/2018 1.1 1 0 -0.4 1.7
1/31/2018 1.3 1 0 -0.4 1.5
12/31/2017 1.3 0.9 0 -0.4 2.2
11/30/2017 1.5 0.9 0 -0.4 2.7
10/31/2017 1.4 0.9 0 -0.4 2.4
9/30/2017 1.6 1.2 0 -0.4 2.6
8/31/2017 1.5 1.2 0 -0.4 2.4
7/31/2017 1.3 1.2 0 -0.4 1.9
6/30/2017 1.3 1.2 0 -0.4 2.4
5/31/2017 1.4 0.9 0 -0.4 3.3
4/30/2017 1.9 1.3 0 -0.4 4.2
3/31/2017 1.5 0.7 0 -0.4 3.8
2/28/2017 2 0.8 0 -0.4 4.3
1/31/2017 1.7 0.9 0 -0.4 3.8
12/31/2016 1.1 0.9 0 -0.4 1.6
11/30/2016 0.6 0.8 0 -0.4 0.1
10/31/2016 0.5 0.7 0 -0.4 -0.4
9/30/2016 0.4 0.8 0 -0.4 -1.3
8/31/2016 0.2 0.8 0 -0.4 -1.8
7/31/2016 0.2 0.9 0 -0.4 -2.4
6/30/2016 0 0.8 0 -0.4 -3
5/31/2016 -0.1 0.8 0 -0.4 -3.7
4/30/2016 -0.3 0.7 0 -0.4 -4.3
3/31/2016 0 1 0 -0.4 -4
2/29/2016 -0.1 0.9 0.1 -0.3 -3.9
1/31/2016 0.3 1 0.1 -0.3 -2.8
12/31/2015 0.3 0.9 0.1 -0.3 -2.9
11/30/2015 0.1 0.9 0.1 -0.2 -3
10/31/2015 0.4 1.5 0.1 -0.2 -3.1
9/30/2015 0.2 1.3 0.1 -0.2 -3.1
8/31/2015 0.4 1.4 0.1 -0.2 -2.6
7/31/2015 0.5 1.4 0.1 -0.2 -2.1
6/30/2015 0.5 1.2 0.1 -0.2 -2.1
5/31/2015 0.6 1.3 0.1 -0.2 -1.9
4/30/2015 0.2 0.9 0.1 -0.2 -2
3/31/2015 -0.1 0.6 0.1 -0.2 -2.2
2/28/2015 -0.3 0.7 0.1 -0.2 -2.8
1/31/2015 -0.6 0.6 0.1 -0.2 -3.5
12/31/2014 -0.2 0.7 0.1 -0.2 -2.7
11/30/2014 0.3 0.7 0.1 -0.2 -1.5
10/31/2014 0.4 0.7 0.1 -0.2 -1.3
9/30/2014 0.3 0.8 0.1 -0.2 -1.5
8/31/2014 0.4 0.9 0.2 -0.1 -1.5
7/31/2014 0.4 0.8 0.2 -0.1 -1.2
6/30/2014 0.5 0.8 0.2 -0.1 -1
5/31/2014 0.5 0.7 0.3 0 -1.2
4/30/2014 0.7 1 0.3 0 -1.3
3/31/2014 0.5 0.7 0.3 0 -1.7
2/28/2014 0.7 1 0.3 0 -1.7
1/31/2014 0.8 0.8 0.3 0 -1.4
12/31/2013 0.8 0.7 0.3 0 -0.8
11/30/2013 0.9 1 0.3 0 -1.1
10/31/2013 0.7 0.8 0.5 0 -1.2
9/30/2013 1.1 1 0.5 0 -0.9
8/31/2013 1.3 1.1 0.5 0 -0.9
7/31/2013 1.6 1.1 0.5 0 -0.1
6/30/2013 1.6 1.2 0.5 0 0.2
5/31/2013 1.4 1.2 0.5 0 -0.3
4/30/2013 1.2 1 0.8 0 -0.2
3/31/2013 1.7 1.5 0.8 0 0.6
2/28/2013 1.9 1.3 0.8 0 1.3
1/31/2013 2 1.3 0.8 0 1.8
12/31/2012 2.2 1.5 0.8 0 2.1
11/30/2012 2.2 1.4 0.8 0 2
10/31/2012 2.5 1.5 0.8 0 2.5
9/30/2012 2.6 1.5 0.8 0 2.7
8/31/2012 2.6 1.5 0.8 0 2.7

Since the tightening cycle began, eurozone growth has slowed sharply. Composite PMI readings suggest Germany and Italy are already tipping into recession, with Spain and France likely to follow them. The looming energy shortages and ECB tightening will only make things worse in terms of growth. As a result, the swaps market is now pricing in a terminal deposit rate between 1.25-1.50%. Fragmentation risks have not been clearly addressed by the new Transmission Protection Instrument (TPI) that was unveiled (sort of) at the July meeting.


Date Germany France Italy Spain Eurozone
8/31/2022 47.6 49.8     49.2
7/31/2022 48.1 51.7 47.7 52.7 49.9
6/30/2022 51.3 52.5 51.3 53.6 52
5/31/2022 53.7 57 52.4 55.7 54.8
4/30/2022 54.3 57.6 54.5 55.7 55.8
3/31/2022 55.1 56.3 52.1 53.1 54.9
2/28/2022 55.6 55.5 53.6 56.5 55.5
1/31/2022 53.8 52.7 50.1 47.9 52.3
12/31/2021 49.9 55.8 54.7 55.4 53.3
11/30/2021 52.2 56.1 57.6 58.3 55.4
10/31/2021 52 54.7 54.2 56.2 54.2
9/30/2021 55.5 55.3 56.6 57 56.2
8/31/2021 60 55.9 59.1 60.6 59
7/31/2021 62.4 56.6 58.6 61.2 60.2
6/30/2021 60.1 57.4 58.3 62.4 59.5
5/31/2021 56.2 57 55.7 59.2 57.1
4/30/2021 55.8 51.6 51.2 55.2 53.8
3/31/2021 57.3 50 51.9 50.1 53.2
2/28/2021 51.1 47 51.4 45.1 48.8
1/31/2021 50.8 47.7 47.2 43.2 47.8
12/31/2020 52 49.5 43 48.7 49.1
11/30/2020 51.7 40.6 42.7 41.7 45.3
10/31/2020 55 47.5 49.2 44.1 50
9/30/2020 54.7 48.5 50.4 44.3 50.4
8/31/2020 54.4 51.6 49.5 48.4 51.9
7/31/2020 55.3 57.3 52.5 52.8 54.9
6/30/2020 47 51.7 47.6 49.7 48.5
5/31/2020 32.3 32.1 33.9 29.2 31.9
4/30/2020 17.4 11.1 10.9 9.2 13.6
3/31/2020 35 28.9 20.2 26.7 29.7
2/29/2020 50.7 52 50.7 51.8 51.6
1/31/2020 51.2 51.1 50.4 51.5 51.3
12/31/2019 50.2 52 49.3 52.7 50.9
11/30/2019 49.4 52.1 49.6 51.9 50.6
10/31/2019 48.9 52.6 50.8 51.2 50.6
9/30/2019 48.5 50.8 50.6 51.7 50.1
8/31/2019 51.7 52.9 50.3 52.6 51.9

Rather, the data suggest that the ECB is relying on its first line of defense against fragmentation. Recall that the ECB said it would first use reinvestment flows to help limit fragmentation and recent data seem to bear this out. ECB statistics on its bond holdings show that net holdings of German, French, and Dutch bonds dropped by EUR18.9 billion through July while net purchases of Italian, Spanish, Portuguese, and Greek bonds totaled EUR17.3 billion. Without these flows, we suspect the 10-year Italian spread would be north of 250 bp by now. That said, the market has yet to mount a credible test of the ECB's will to limit spreads but will have ample opportunity ahead of the September elections in Italy.


This graph represents the 10-year spread of basis points to Germany from 2019 to 2022. This data includes the spread from Italy (orange) at 206 bp, Greece (Purple) with 224 bp, Spain (Black) at 111 bp, and Portugal (red) with 100 bp.

Italian political uncertainty should persist ahead of the September 25 elections. Of note, two parties recently broke away from a short-lived center-left coalition to form a centrist alliance ahead of the vote. Italia Viva, a breakaway party from the Democratic Party formed by former Prime Minister Matteo Renzi, and Carlo Calenda’s Azione together have pledged to continue the foreign policy and domestic reform agenda of outgoing Prime Minister Draghi’s government. Renzi called the alliance a “third pillar” to stand against the left- and right-wing coalitions. The right is led by Giorgia Meloni’s Brothers of Italy, Matteo Salvini’s Lega, and Silvio Berlusconi’s Forza Italia, while the left is led by the Democrats. Recent polls suggest the right-wing alliance will handily win in September. As leader of the likely largest party in parliament, Meloni is tipped to be the next Prime Minister. She has taken pains recently to reassure markets that market-friendly policies and good relations with Brussels will be maintained. However, much-needed structural reforms may be delayed or derailed.

Damn the Recession - Full Speed Ahead!

The BOE hiked rates 50 bp to 1.75% August 4 and signaled further tightening to come. This was the first 50 bp hike since 1995 but the bank said that future policy is not on a pre-set path. Governor Bailey also emphasized that all options are on the table for future meetings and policy is not on a pre-set path, adding that a 50 bp hike now lowers the risk of a more extended tightening cycle later. WIRP suggests a 50 bp hike September 15 is fully priced in, with nearly 35% odds of a larger 75 bp hike. Looking ahead, the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 4.0%.


According to this graph of year over year U.K. CPI from 2015 to 2022, general CPI on 6/30/2022 (red) is seen at a 9.4, Core CPI (green) is a 5.80, CPIH (purple is 8.20), and the Base Rate (blue) is a 1.75.

The BOE finally laid out its plans for Quantitative Tightening (QT) at the last meeting. The bank sees active sales of its holdings starting after a vote at the September meeting. The bank estimated that sales will be around GBP10 billion per quarter and that including redemptions, its gilt holding will decline by around GBP80 billion in the first year of QT. Bank officials said there would be a “high bar” to altering the plan, which means that monetary conditions are set to get even tighter.

The bank is in an unenviable position as inflation continues to surge even as the economy tips into recession. The bank’s updated macro forecasts see the economy entering recession in Q4 and the downturn lasting five quarters. It also sees inflation peaking at 13.3% this October. Obviously, the risks are that these forecasts are too optimistic. It’s worth noting that the next potential Prime Minister Liz Truss has been very critical of the BOE’s performance and has promised a review of its mandate. While Truss has promised to maintain the bank’s independence, it is impossible not to view such a move as political meddling in the sphere of monetary policy. The recent Fed and ECB framework reviews were decided on internally, not by an outside body. Any hint of political interference would be very negative for sterling and gilts.

BOE Forecasts from August (May)
  2022 2023 2024
GDP Growth 3.5% (3.75%) -1.5% (-0.25%) -0.25% (0.25%)
CPI Inflation 13.0% (10.25%) 5.5% (3.5%) 1.5% (1.5%)
Unemployment 3.75% (3.5%) 4.75% (4.25%) 5.75% (5.0%)

U.K. politics are in flux after Prime Minister Boris Johnson resigned. Foreign Secretary Truss is leading former Chancellor Rishi Sunak in the Tory leadership race. The policy divide between Sunak and Truss is mostly along the lines of tax cuts. For now, it appears both are more focused on difficult domestic conditions as Brexit is moved to the back burner. Former Chancellor Sunak is sticking to his long-held stance of fiscal responsibility, while Truss is pledging immediate tax cuts to boost the economy. Of course, a big injection of fiscal stimulus may not be the best idea when headline inflation is running close to 10% as it could require an even greater monetary policy response from the BOE than what would ordinarily be needed. At some point, Brexit is likely to move back to the front burner as Truss has pledged to unilaterally rewrite portions of the deal. If so, the EU has pledged retaliatory measures.

Steady as She Goes

The July 20-21 Bank of Japan meeting ended with a dovish hold. As we expected, the macro forecasts were tweaked but do not signal a shift anytime soon from its current ultra-dovish stance. Governor Haruhiko Kuroda emphasized then that “we have no intention at all of raising rates under the yield curve control framework. We also have zero intention of expanding the 0.25% range on either side of the yield target. Right now, we need to continue to tenaciously pursue monetary easing.” A policymaker can’t get any more explicit than that and we maintain our view that current policy settings will be maintained through the end of Kuroda’s term in early April.


Date CPI (R1) Core (ex-fresh food) (R1) Policy Rate (R1) PPI (L1) Core ex-energy (R1)
8/19/2022     -0.1    
7/31/2022 2.6 2.4 -0.1 8.6 1.2
6/30/2022 2.4 2.2 -0.1 9.4 1
5/31/2022 2.5 2.1 -0.1 9.3 0.8
4/30/2022 2.5 2.1 -0.1 10 0.8
3/31/2022 1.2 0.8 -0.1 9.3 -0.7
2/28/2022 0.9 0.6 -0.1 9.4 -1
1/31/2022 0.5 0.2 -0.1 9 -1.1
12/31/2021 0.8 0.5 -0.1 8.6 -0.7
11/30/2021 0.6 0.5 -0.1 8.9 -0.6
10/31/2021 0.1 0.1 -0.1 8 -0.7
9/30/2021 0.2 0.1 -0.1 6.2 -0.5
8/31/2021 -0.4 0 -0.1 5.6 -0.5
7/31/2021 -0.3 -0.2 -0.1 5.6 -0.6
6/30/2021 -0.5 -0.5 -0.1 4.9 -0.9
5/31/2021 -0.8 -0.6 -0.1 4.8 -0.9
4/30/2021 -1.1 -0.9 -0.1 3.5 -0.9
3/31/2021 -0.4 -0.3 -0.1 1 0
2/28/2021 -0.5 -0.5 -0.1 -0.9 0
1/31/2021 -0.7 -0.7 -0.1 -1.8 0
12/31/2020 -1.2 -1 -0.1 -2.1 -0.4
11/30/2020 -0.9 -0.9 -0.1 -2.4 -0.3
10/31/2020 -0.4 -0.7 -0.1 -2.2 -0.2
9/30/2020 0 -0.3 -0.1 -0.8 0
8/31/2020 0.2 -0.4 -0.1 -0.6 -0.1
7/31/2020 0.3 0 -0.1 -0.9 0.4
6/30/2020 0.1 0 -0.1 -1.6 0.4
5/31/2020 0.1 -0.2 -0.1 -2.7 0.4
4/30/2020 0.1 -0.2 -0.1 -2.4 0.2
3/31/2020 0.4 0.4 -0.1 -0.4 0.6
2/29/2020 0.4 0.6 -0.1 0.7 0.6
1/31/2020 0.7 0.8 -0.1 1.5 0.8
12/31/2019 0.8 0.7 -0.1 0.9 0.9
11/30/2019 0.5 0.5 -0.1 0.1 0.8
10/31/2019 0.2 0.4 -0.1 -0.4 0.7
9/30/2019 0.2 0.3 -0.1 -1.1 0.5
8/31/2019 0.3 0.5 -0.1 -0.9 0.6
7/31/2019 0.5 0.6 -0.1 -0.7 0.6
6/30/2019 0.7 0.6 -0.1 -0.2 0.5
5/31/2019 0.7 0.8 -0.1 0.6 0.5
4/30/2019 0.9 0.9 -0.1 1.3 0.6
3/31/2019 0.5 0.8 -0.1 1.3 0.4
2/28/2019 0.2 0.7 -0.1 0.9 0.4
1/31/2019 0.2 0.8 -0.1 0.5 0.4
12/31/2018 0.3 0.7 -0.1 1.4 0.3
11/30/2018 0.8 0.9 -0.1 2.2 0.3
10/31/2018 1.4 1 -0.1 3 0.4
9/30/2018 1.2 1 -0.1 3 0.4
8/31/2018 1.3 0.9 -0.1 3.1 0.4
7/31/2018 0.9 0.8 -0.1 3.1 0.3
6/30/2018 0.7 0.8 -0.1 2.9 0.2
5/31/2018 0.7 0.7 -0.1 2.7 0.3
4/30/2018 0.6 0.7 -0.1 2.2 0.4
3/31/2018 1.1 0.9 -0.1 2 0.5
2/28/2018 1.5 1 -0.1 2.5 0.5
1/31/2018 1.4 0.9 -0.1 2.7 0.4
12/31/2017 1 0.9 -0.1 3 0.3
11/30/2017 0.6 0.9 -0.1 3.5 0.3
10/31/2017 0.2 0.8 -0.1 3.5 0.2
9/30/2017 0.7 0.7 -0.1 3 0.2
8/31/2017 0.7 0.7 -0.1 2.8 0.2
7/31/2017 0.4 0.5 -0.1 2.5 0.1
6/30/2017 0.4 0.4 -0.1 2.2 0
5/31/2017 0.4 0.4 -0.1 2.1 0
4/30/2017 0.4 0.3 -0.1 2.1 0
3/31/2017 0.2 0.2 -0.1 1.4 -0.1
2/28/2017 0.3 0.2 -0.1 1 0.1
1/31/2017 0.4 0.1 -0.1 0.5 0.2
12/31/2016 0.3 -0.2 -0.1 -1.2 0.1
11/30/2016 0.5 -0.4 -0.1 -2.3 0.2
10/31/2016 0.1 -0.4 -0.1 -2.7 0.3
9/30/2016 -0.5 -0.5 -0.1 -3.3 0.2
8/31/2016 -0.5 -0.5 -0.1 -3.8 0.4
7/31/2016 -0.4 -0.5 -0.1 -4.2 0.5
6/30/2016 -0.4 -0.4 -0.1 -4.5 0.7
5/31/2016 -0.5 -0.4 -0.1 -4.6 0.7
4/30/2016 -0.3 -0.4 -0.1 -4.4 0.8
3/31/2016 0 -0.3 -0.1 -4 0.9
2/29/2016 0.2 0 -0.1 -3.7 1
1/31/2016 -0.1 -0.1 -0.1 -3.4 0.9
12/31/2015 0.2 0.1 0.1 -3.6 1.2
11/30/2015 0.3 0.1 0.1 -3.7 1.3
10/31/2015 0.3 -0.1 0.1 -3.8 1.1
9/30/2015 0 -0.1 0.1 -4 1.2
8/31/2015 0.2 -0.1 0.1 -3.8 1
7/31/2015 0.2 0 0.1 -3.2 0.9
6/30/2015 0.4 0.1 0.1 -2.4 0.8
5/31/2015 0.5 0.1 0.1 -2.2 0.7
4/30/2015 0.6 0.3 0.1 -2.1 0.7
3/31/2015 2.3 2.2 0.1 0.7 2.5
2/28/2015 2.2 2 0.1 0.4 2.5
1/31/2015 2.4 2.2 0.1 0.3 2.5
12/31/2014 2.4 2.5 0.1 1.8 2.5
11/30/2014 2.4 2.7 0.1 2.6 2.5
10/31/2014 2.9 2.9 0.1 2.8 2.7
9/30/2014 3.2 3 0.1 3.6 2.7
8/31/2014 3.3 3.1 0.1 4 2.7
7/31/2014 3.4 3.3 0.1 4.4 2.8
6/30/2014 3.6 3.3 0.1 4.5 2.7
5/31/2014 3.7 3.4 0.1 4.4 2.7
4/30/2014 3.4 3.2 0.1 4.2 2.7
3/31/2014 1.6 1.3 0.1 1.7 0.8
2/28/2014 1.5 1.3 0.1 1.8 0.8
1/31/2014 1.4 1.3 0.1 2.5 0.7
12/31/2013 1.6 1.3 0.1 2.5 0.7
11/30/2013 1.5 1.2 0.1 2.6 0.5
10/31/2013 1.1 0.9 0.1 2.5 0.3
9/30/2013 1.1 0.7 0.1 2.3 0
8/31/2013 0.9 0.8 0.1 2.3 0
7/31/2013 0.7 0.7 0.1 2.1 -0.1
6/30/2013 0.2 0.4 0.1 1.2 -0.2
5/31/2013 -0.3 0 0.1 0.6 -0.3
4/30/2013 -0.7 -0.4 0.1 0.1 -0.6
3/31/2013 -0.9 -0.5 0.1 -0.5 -0.7
2/28/2013 -0.7 -0.3 0.1 -0.1 -0.8
1/31/2013 -0.3 -0.2 0.1 -0.4 -0.6
12/31/2012 -0.1 -0.2 0.1 -0.7 -0.5
11/30/2012 -0.2 -0.1 0.1 -1.1 -0.4
10/31/2012 -0.4 0 0.1 -1.1 -0.5
9/30/2012 -0.3 -0.1 0.1 -1.5 -0.5
8/31/2012 -0.4 -0.3 0.1 -2 -0.4
7/31/2012 -0.4 -0.3 0.1 -2.2 -0.4
6/30/2012 -0.2 -0.2 0.1 -1.5 -0.4
5/31/2012 0.2 -0.1 0.1 -0.9 -0.5
4/30/2012 0.4 0.2 0.1 -0.7 -0.3
3/31/2012 0.5 0.2 0.1 0.3 -0.3
2/29/2012 0.3 0.1 0.1 0.4 -0.3
1/31/2012 0.1 -0.1 0.1 0.3 -0.6

The BOJ remains the major outlier in a world of rising rates. We expect the market to eventually test the bank’s resolve to maintaining YCC, something that hasn’t happened since mid-June. That said, we believe the BOJ has unlimited firepower here and is unlikely to blink. Despite recent yen strength, we believe the USD/JPY rally remains intact given ongoing monetary policy divergences between the hawkish Fed and the ultra-dovish BOJ. Kuroda also touched on the exchange rate, noting that “If you were serious about stopping the weaker yen just with rate increases, you would need significant hikes and they would be very damaging to the economy.” Official concern about the exchange rate was likely focused on the pace rather than any particular levels. As such, we believe FX intervention is very unlikely for now.

 
The latest macro forecasts suggest no need to tighten. Yes, core (ex-fresh food) inflation is currently running slightly above the 2% target but the forecasts show that it is expected to fall back below in the next two fiscal years. Much of the rise in core measures is stemming from energy costs. Stripping out both fresh food and energy, inflation is only running around 1%.

BOJ Forecasts from July (April)
  FY22 FY23 FY24
GDP Growth 2.4% (2.9%) 2.0% (1.9%) 1.3% (1.1%)
Core CPI (ex-fresh food) 2.3% (1.9%) 1.4% (1.1%) 1.3% (1.1%)

Kuroda’s replacement has not been named yet but the choice will be key in determining the timing of BOJ policy normalization. The two Deputy Governors Masayoshi Amamiya and Masazumi Wakatabe are seen as potential successors to Governor Kuroda. Many at the BOJ believe that besides hitting the 2% inflation target, higher wages are also needed to justify liftoff. Amamiya recently expressed concern about rising wages next fiscal year, while Wakatabe has sounded less concerned. Of note, both of their terms end in late March but are widely expected to be appointed to a second 5-year term. Another potential candidate is former Deputy Governor Hiroshi Nakaso, who served during Kuroda’s first term and currently heads up a private sector research institute. We expect to see some hints of progress on the succession process this autumn.

Dollar Bloc and Scandies

Made up mostly of commodity currencies, the dollar bloc and Scandies are most at risk from slowing global growth. Yet the central banks continue to tighten in order to help limit inflation. The RBNZ is expected to hike its policy rate to 4.0% over the next 6 months. Although it was the first of the majors to hike and one of the most aggressive, it has not helped NZD very much as it is the worst performing YTD within the dollar bloc. Elsewhere, in Australia, the RBA is expected to hike its policy rate to 4.2% over the next 12 months. The economy is heavily dependent on exports to China. With the mainland economy slowing sharply, it is only a matter of time before Australia also feels the chill. CAD has been the best performing major currency YTD, due in large part to its status as an oil exporter as well as its strong ties to the U.S. With the U.S. economy remaining resilient, this should help Canada weather the storm as well. The BOC is expected to hike its policy rate to 3.75% over the next 6 months.

Norway is also a major oil exporter, which has helped NOK outperform within the Scandies. Norges Bank is expected to hike its policy rate to 3.25% over the next 12 months. Of note, new Governor Bache began tightening at her first meeting in March. On the other hand, Sweden is heavily dependent on trade with the eurozone, which is slipping into recession even as the ECB tightens and energy shortages loom. No wonder SEK is the second worst performing major currency YTD, ahead of only JPY. Yet the Riksbank is expected to hike policy rate to 3.0% over the next 12 months. Erik Thedeen will become Governor after Ingves’ term is over at the end of 2022 and he is expected to continue the tightening cycle.


Date Norges Bank RBNZ RBA BOC Riksbank
8/22/2022 1.75 3 1.85 2.5  
7/29/2022   2.5 1.35 2.5  
6/30/2022 1.25   0.85 1.5 0.75
5/31/2022 0.75 2 0.35 1  
4/29/2022   1.5 0.1 1 0.25
3/31/2022 0.75   0.1 0.5  
2/28/2022   1 0.1 0.25 0
1/31/2022 0.5     0.25  
12/31/2021 0.5   0.1 0.25  
11/30/2021 0.25 0.75 0.1 0.25 0
10/29/2021   0.5 0.1 0.25  
9/30/2021 0.25   0.1 0.25 0
8/31/2021 0 0.25 0.1 0.25  
7/30/2021   0.25 0.1 0.25 0
6/30/2021 0   0.1 0.25  
5/31/2021 0 0.25 0.1 0.25  
4/30/2021   0.25 0.1 0.25 0
3/31/2021 0   0.1 0.25  
2/26/2021   0.25 0.1 0.25 0
1/29/2021 0     0.25  
12/31/2020 0   0.1 0.25  
11/30/2020 0 0.25 0.1 0.25 0
10/30/2020     0.25 0.25  
9/30/2020 0 0.25 0.25 0.25 0
8/31/2020 0 0.25 0.25 0.25  
7/31/2020     0.25 0.25 0
6/30/2020 0 0.25 0.25 0.25  
5/29/2020 0 0.25 0.25 0.25  
4/30/2020     0.25 0.25 0
3/31/2020 0.25 0.25 0.25 0.25  
2/28/2020   1 0.75 1.75 0
1/31/2020 1.5     1.75  
12/31/2019 1.5   0.75 1.75 0
11/29/2019   1 0.75 1.75  
10/31/2019 1.5   0.75 1.75 -0.25
9/30/2019 1.5 1 1 1.75 -0.25
8/30/2019 1.25 1 1 1.75  
7/31/2019     1 1.75 -0.25
6/28/2019 1.25 1.5 1.25 1.75  
5/31/2019 1 1.5 1.5 1.75  
4/30/2019     1.5 1.75 -0.25
3/29/2019 1 1.75 1.5 1.75  
2/28/2019   1.75 1.5 1.75 -0.25
1/31/2019 0.75     1.75  
12/31/2018 0.75   1.5 1.75 -0.25
11/30/2018   1.75 1.5 1.75  
10/31/2018 0.75   1.5 1.75 -0.5
9/28/2018 0.75 1.75 1.5 1.5 -0.5
8/31/2018 0.5 1.75 1.5 1.5  
7/31/2018     1.5 1.5 -0.5
6/29/2018 0.5 1.75 1.5 1.25  
5/31/2018 0.5 1.75 1.5 1.25  
4/30/2018     1.5 1.25 -0.5
3/30/2018 0.5 1.75 1.5 1.25  
2/28/2018   1.75 1.5 1.25 -0.5
1/31/2018 0.5     1.25  
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One basis point or bp is 1/100th of a percent (0.01% or 0.0001).

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