Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
In this week’s update – Moody’s described the US economy as “slowcession” predicting the US economy will go flat but not tip into a recession. In Europe, manufacturing remains subdued with signs of improving, whereas services have really picked up. Finally, the geopolitics surrounding Russia & Ukraine saw developments as China attempted to push for peace. Continue reading for the full market update.
The term “slowcession” is one used by Moody’s to describe the US economy – growth will go flat but it won’t tip into recession. The US has dominated news this week and it’s not surprising why. On Friday we had key releases for consumer spending and personal consumption expenditure (PCE) inflation (the Fed’s preferred measure of inflation). Both shot up and, frankly, the former explains the latter. January’s PCE inflation surged +0.6% m/m to 5.4% y/y while the core rate also surged +0.6% m/m to 4.7% y/y. The forecast, for both, was +0.4% m/m so this comes in quite above. Consumer spending shot up +1.8% m/m, its largest increase since March 2021 while December’s data was revised higher by 0.1%. Adjusted for inflation, consumer spending increased 1.1%. Consumers boosted spending on long-lasting manufactured goods (motor vehicles, household furnishings & equipment) as well as spending more on dining out and recreation. Wages & salaries rose 0.9%. This leaves the odds of a 0.50% rate hike by the Fed a very real prospect – though it should be noted we still have plenty of data due before the next Federal Open Market Committee (FOMC) sitting. Forecasters are now saying Fed rates will hit as high as 6.5% before peaking. So no surprise global yields keep pushing higher and therefore taking its toll on the valuation of risk assets. It may be a possibility that we will have to endure this for a bit longer – at least to the end of Q1. Inflation, in the US, is rising as a consequence of strong consumer spending. The same cannot be said of other regions (except for Brazil where there has been an improvement in the domestic picture and healthy Foreign Direct Inflows during 2022). In 2022, US personal incomes were revised up $77.1bn to $388.1bn – much stronger than initially estimated. Wages & salaries were revised up $115.2bn to $303bn meaning consumers saved more than expected. The savings rate rose to 3.7% (from 2.7%) in Q3 and was boosted 0.5% to 3.9% in Q4. For now, the Fed will only win the inflation battle if a recession sets in.
It’s not exactly doom and gloom everywhere else. Flash Purchasing Managers Index (PMI) (Activity) indicators released this week surprised significantly to the upside in Europe with composite readings in excess of 50 (over 50 = expansion). Granted, manufacturing remains subdued and in contraction but shows signs of improving. Services however have really pricked up. Services means spending! Asian manufacturing seems to be on a slow burner but there may be a lag effect here. Asian exports will be highly dependent on China’s economic pick-up and the latter is moving slowly. Resource oriented countries are faring better (Indonesia, Malaysia).
Finally, geopolitics – Russia & Ukraine. A key development comes with China’s attempt to push for peace. They have threatened to supply Russia with weapons if the Ukraine and US are not prepared to come to the negotiating table. We have just witnessed a surprise visit by President Biden to Kyiv in what, on the surface, presents a strong show of allied support. However support for Ukraine, in the West, while still popular is slowly starting to fade. Who buckles first? The West (when support ceases) or Russia (as it struggles more and more to balance its books on the back of declining oil prices)? Russia’s economy proved far more resilient than anyone expected in 2022. A decline of -10% has been expected - instead it fell just -2.1% and this despite losing access to some $300bn of international reserves. It has found new markets for oil and gas in Asia and has maintained the supply of its consumer goods through a grey imports scheme. Its challenge now is trying to meet its oil and gas revenue target and its widening budget deficit. It would have to double its planned spending from its National Wealth Sovereign (NWS) fund risking higher inflation. Analysis by Scope (a European ratings agency) forecasts the deficit to rise to -3.5% of GDP (vs the government’s forecast of -2%). For now though, Russia can still keep dipping into its NWS fund to finance their deficit.