Global Economy & Markets, Weekly Roundup 24/01/23

PMI business indicators add to evidence that the outlook for euro area has stopped deteriorating 
              
Key Takeaways

US economic announcements for December (retail sales, industrial production) came out weaker-than-expected, suggesting that momentum slowed by the end of the quarter, albeit overall Q4 real GDP growth (due on January 26th) is expected at an above trend rate of +2.5% qoq saar from +3.2% in Q3 (+1.9% yoy in Q3). Forward-looking business indicators suggest that growth could slow in Q1.2023, reflecting the lag of monetary policy tightening (+425 basis points yoy). 

Slowing activity momentum and decelerating US CPI keeps the FED on track to downshift its pace of tightening to 25 bps from 50 bps (current FFR range: 4.25% to 4.5%) at the upcoming meeting, due on February 1st, albeit it is a close call. The prospect of a step down in the pace of FED interest rate hikes has supported US equities and bonds YtD (+5% and +3%, respectively), with positive correlation between stock and bond returns at the highest level since 2000.  

On the other side of the Atlantic, “hawkish” ECB members (Knot) pushed back against expectations for a similar downshift by the ECB in March (current DFR: 2.0%), with 10-Year Bund yields increasing by circa 14 basis points in the last two trading sessions (Friday, Monday) and Italian bond spreads widening by 11 bps. So far this month, Bund yields have fallen by 34 bps to 2.19% and BTP spreads have narrowed by 32 bps to 182 bps. 

Euro area equities paused for breath in the past week. So far this month, the SXXE index has increased by +9% on the back of significantly lower natural gas prices and relaxation of covid restrictions in China. Banks have led the increase (+10%) as the profitability outlook remains favorable due to higher rates. Deteriorating asset quality and higher funding costs concerns remain, for now, on the sidelines as macroeconomic prospects stabilize. 

Indeed, the preliminary euro area composite output PMI index for January rose marginally above the expansion/contraction threshold of 50 for the first time in seven months (50.2 from 49.3 in December and a low of 47.3 in October 2022). 

On Wednesday, the Bank of Japan stood pat (Yield Curve Control, Negative Interest Rate Policy), with the JPY depreciating slightly. Policy board members expect the CPI excluding fresh food, the BOJ’s preferred measure of inflation, to decelerate towards 2% next year from 4% currently. According to BOJ, the effects of a pass-through of cost increases to CPI led by a rise in import prices due to, inter alia, the significant depreciation of the JPY on a year-over-year basis by -9% (trade weighted index) are expected to wane. 

Financial markets have begun to price a gradual shift from its ultra-accommodate monetary policy, following the unexpected adjustment of the upper range for its 10-Year JGB yield target of 0% to +0.5% from +0.25% in December 2022. As a result, interest rate differentials have narrowed by 100 bps to 250 bps in the past two months, supporting the JPY against the USD. 


With risks to consumer prices remaining to the upside, an aggressive acceleration of Japanese government bond purchases in the past three months ($150 billion) in order to defend its yield curve upper cap (see graph below) and a new BOJ Governor in April, a gradual policy shift is likely, probably leading to higher interest rates and a stronger JPY. 

 
Global Economy & Markets, Weekly Roundup 24/01/23
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