The U.S is fairly insulated, except for Covid, and as the number one economy, they tend to bounce back much quicker than other countries. Not only that, but they are also willing to pump as much money into the system as it takes for the desired effect. We are also talking about the reserve currency of the world. Not bad for a country in a technical recession which is likely to still be the case in Q3.
Central banks were slow to react to inflation with certain central bankers being the last people on the planet to consider inflation “transitory”! Now with Interest rates destined to rise further and remain high for longer, central banks, in their determination to control inflation, will push economies into recession. It is the only solution to fight and regain control of inflation. Only when they feel confident, and they are back in control, will they consider slowly lowering rates to reboot the economy, although free money has gone for the foreseeable future…at least! I also expect they will be more cautious with any QE in the future when the next crisis strikes. We also need to accept, as do the central banks, that most of the inflation has been driven by the supply-side not consumer demand.
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Europe: still a long way to go to catch up
The Euro is closing in on levels not seen since the Euro was launched as a physical currency in January 2002, and although it is great to see they have lifted rates back into positive territory they still have a long way to go to catch up with other central banks and remove some of the pressure from the Euro.
Of course, it was impossible at the beginning of the year to predict Russia would invade Ukraine, which severely impacted Europe, and triggered a mass of sanctions against Russia and Putin responded by cutting off Europe’s gas supplies, forcing power prices to levels never seen before.
Another area greatly impacted was food, as the two countries are major exporters of grains and fertilizer. Fortunately, prices are now well off their highs driven by Covid and the war. It does seem as if companies are now profiteering from the situation. They had already increased their profit margins to decade highs of 15% and it seems they have now increased that further as they are reluctant to pass on savings to consumers yet. This should see PPI drop and CPI remain higher for longer, until consumers cut back as the recession takes hold and then companies will be forced to drop prices…helping to reduce inflation.
UK: entering a perfect storm
The UK has experienced the same impactors as Europe with additional pressure caused by a new Prime Minister after Boris Johnson was pushed out by his own party. Liz Truss has quickly added power price caps to protect households plus the new Chancellor has cut taxes and removed planned corporate tax increases in the hope of cushioning the economy. However, investors are concerned about how these measures will be paid for with costs of around £200bn.
The UK has entered a perfect storm and although they have stabilised for the moment, we just saw one of the worst days on record for both Sterling and gilts. Sterling hit an all-time low of $1.035 in Asian hours and although bond markets have been under pressure everywhere with high inflation and interest rate rises, the drop in the UK debt market this year is currently over 25%, one of the worst! Will the GBP/USD trade at parity, I am not sure, but the option markets imply there is a 43% chance of it before the end of 2022.
The UK has very bad memories of inflation from the 1970s and 1980s. Here is a chart highlighting UK inflation over the last 70 years that I found in the Evening Standard recently.
With October’s power price cap increasing we should expect one more spike in inflation before it starts to dip. The previously expected spikes in inflation to 15%+ will not occur due to the government’s price cap on industry for six months and households for two years.
With the war on Europe’s doorstep, I expect the Euro and Sterling to remain under pressure for some time. Strategic energy supplies are not like our domestic ones where we can switch overnight, countries need to make agreements and order for future supplies. Fortunately, many countries have managed to build storage in advance of the oncoming winter, however, will it be enough? Otherwise, we will experience blackouts and shorter working days or weeks for industry which does not bode well for the economy.
Japan: feeling the heat
The yen has been another currency feeling the heat from the rise of the dollar and their position on maintaining the last negative rate which has made them an easy target (even the Swiss moved from -0.25% to plus 0.5% recently) and after JPY broke 140 and looked as though it could test 150, the Bank of Japan threatened intervention to provide support. Whether the threat was enough, or they have been active, it has steadied the Yen for the moment. It should be noted that they are still providing stimulus and their inflation, although increasing, is in the 3% range!
Oil: US will start replacing reserves
Although the markets were spooked and we saw WTI hit $130 after Russia invaded Ukraine, but prices have dropped back to around $80. This is the level at which the U.S is expected to replace their oil strategic reserves. Other reasons for the drop include the fear of recession drastically reducing demand.
Another when it was around $120, was that the oil market had become a merry-go-round with countries replacing each other as buyers and sellers. Those that placed sanctions on Russia needed other suppliers. and this occurred naturally as China, India and even Saudi Arabia were happy to purchase Russian oil at a market discount, releasing other suppliers to deliver to Europe.
Macro summary
Although the economic landscape seems easy to predict as we prepare to head into 2023, we still need to have one eye on Covid, just in case it decides to mutate and surge again! China is still suffering from lockdowns in over 20 cities due to their Zero Covid policy.
The world is heading into recession, the big question is how deep it will be and how many jobs will it cost!
Currency impactors
• Domestic economic conditions and data
• Global economic conditions and data
• Domestic interest rate moves and expectations
• Interest rate differentials
• Geopolitical influences
