On Thursday, US central bank governor Jerome Powell said to the House of Representatives that The Federal Reserve’s commitment to curbing 40-year inflation is “unconditional,” but it carries the risk of rising unemployment. On Wednesday, Powell told the US Senate Banking Committee that the Fed is not trying to trigger a recession but is “certainly possible” due to global events beyond its control, particularly the effects of the war in Ukraine and the COVID-19 pandemic. At the same time, Powell expects US economic growth to accelerate in the year’s second half.
On Thursday, another Fed official, Michelle Bowman, said that she supports a 75 basis point rate hike in July, followed by a 50 basis point increase at the next few meetings. That statement coincides with Reuters polls. Economists polled by Reuters this week forecast that the Fed will hold another 75 basis point rate hike next month, followed by a 0.5% hike in September.
New jobless claims fell last week from 231,000 to 229,000, while the key PMI for manufacturing and service sector activity fell to 52.5 (from 57) and 51.6 (from 53.4), respectively.
As the stock market closed yesterday, the Dow Jones Index (US30) increased by 0.64% and the S&P 500 Index (US500) added 0.95%. The technology index NASDAQ (US100) jumped by 1.62%.
Stock markets in Europe were mostly trading lower yesterday. German DAX (DE30) lost 1.76%, French CAC 40 (FR40) decreased by 0.56%, Spanish IBEX 35 (ES35) fell by 0.48%, British FTSE 100 (UK100) was 0.97% down.
German and French PMI data showed that the Eurozone economy is starting to show signs of a slowdown. In Germany, the manufacturing PMI decreased from 54.8 to 52 while the services PMI dropped from 55 to 52.4. In France, the manufacturing PMI decreased from 58.3 to 54.4, and the services PMI declined from 54.6 to 51. Typically, a PMI falling below 50 is a sign of recession in which the central bank raises interest rates. At that time, Fed spokesman Kazimir said yesterday that some Eurozone countries might face a short-term recession.
The Norwegian Central Bank surprised markets by raising its interest rate by 50 bps from 0.75% to 1.25%. Concerns about rising inflation in a tight labor market were the reasons for the scale of the increase. Norway’s inflation rate was 5.7% y/y in May versus 5.4% y/y in April. It is the highest level since December 1988.
Ukraine and Moldova officially received candidate status for EU accession.
The Russian State Duma called for bombing the US Embassy in Kyiv because of the deliveries of MLRSs to Ukraine. Such a statement was made by the deputy chairman of the Duma committee for defense, Yuriy Shvytkin. He said that the United States “is bringing World War III closer” by supplying HIMARS multiple-launch rocket systems. At the same time, Estonian Prime Minister Kaja Kallas said that in case of a Russian invasion, Estonia would be wiped off the face of the earth because of the ineffective NATO plan to defend the Baltic states. She called for sending at least 20,000 to 25,000 NATO soldiers to each Baltic country.
Natural gas futures fell more than 5% yesterday on the news of reserves. US domestic natural gas inventories increased by 74 billion cubic feet over the week. Meanwhile, total natural gas in storage is 2.169 trillion cubic feet, 305 billion cubic feet less than a year ago, and 331 billion cubic feet below the five-year average.
Official weekly estimates of US oil inventories had to be released on Thursday, but technical problems delayed those numbers until next week, the US Energy Information Administration said. Russia continues to find alternative buyers for its oil, with China and India among the biggest buyers. China’s crude oil imports from Russia increased by 55% in May from a year earlier to a record high.
Asian markets closed yesterday in green territory. Japan’s Nikkei 225 (JP225) gained 0.08%, Hong Kong’s Hang Seng (HK50) added 1.26%, and Australia’s S&P/ASX 200 (AU200) closed with a gain of 0.31%.
The nationwide core Consumer Price Index was 2.1% for the second month in a row and again exceeded the Bank of Japan’s target level. This data challenges the Bank of Japan’s view that the recent price increase is temporary and does not require a withdrawal of monetary stimulus. Such sentiment provided a brief boost to the Japanese yen. But with wage growth slowing, many analysts expect the Bank of Japan to remain on a soft monetary policy rather than fighting inflation by raising interest rates.
Main market quotes:
S&P 500 (F) (US500) 3,795.72 +35.83 (+0.95%)
Dow Jones (US30) 30,677.36 +194.23 (+0.64%)
DAX (DE40) 12,912.59 −231.69 (−1.76%)
FTSE 100 (UK100) 7,020.45 −68.77 (−0.97%)
USD Index 104.35 +0.16 (+0.15%)
Important events for today:
– Japan National Core Consumer Price Index at 02:30 (GMT+3);
– UK Retail Sales (m/m) at 09:00 (GMT+3);
– Eurozone German Ifo Business Climate Index (m/m) at 11:00 (GMT+3);
– Eurozone EU Leaders Summit at 13:00 (GMT+3);
– Australia RBA Governor Lowe Speaks at 14:30 (GMT+3);
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
– Curtailment has a special meaning in electric power systems. It describes any action that reduces the amount of electricity generated to maintain the balance between supply and demand – which is critical for avoiding blackouts.
Recently, curtailment has made news in states like California and Texas that are adding a lot of wind and solar power. On very windy or sunny days, these sources may produce more electricity than the grid can take. So grid managers reduce production to manage that oversupply.
This can be a lost opportunity. Electricity from solar and wind, as well as existing nuclear plants, is inexpensive and emits less greenhouse gases than fossil fuels, so it may be in society’s interest to keep these generators running.
A special kind of surplus
Consumers know about shortages and surpluses in the goods they buy. Shortages mean that shoppers can’t get that PlayStation 5 for Christmas – or, more critically, the bread, water or baby formula they need.
Surpluses look different, like unsold books classified as remainders or Easter candy discounted 80% at local drug stores on Monday morning.
But electricity is not like these goods. On today’s electric grid, shortages and surpluses can both result in the exact same thing – a blackout.
The North American grid transmits electricity as alternating current that changes direction back and forth, like water ebbing and flowing from a vintage hand pump as the handle is pushed up and down. Modern electricity grids require precise levels of frequency – the back-and-forth motion of power – to function properly.
The grid is designed to function at 60 hertz, which means that the flow of electric current shifts back and forth 60 times per second. This is achieved, in part, by ensuring that the amount of electricity produced at any given time is equal to the amount of electricity being used. If too little electricity is produced, frequency on the system drops. If too much electricity is produced, then frequency increases.
Modern power plants are designed to operate within a relatively narrow range around 60 hertz. If the actual frequency on the grid is outside that range, the plant can disconnect itself from the system. If enough plants do that, it causes a blackout.
As the U.S. electric power industry shifts increasingly to renewable sources, the national power grid will require major updates.
Managing the flow
In some parts of the U.S., mostly the Southeast and the West, the same companies generate electricity and deliver it to customers. When power plants in a utility’s territory generate more electricity than customers are using, the company will simply produce less electricity from its most expensive power plant, or temporarily shut it off altogether.
But other states have restructured their electricity markets so that some companies produce power and others deliver it to customers. In these competitive markets, curtailment raises complex issues. Power generators stay in business by generating and selling power, so when demand drops, grid operators need a system to ensure that they make curtailment decisions fairly.
Often the first tool for choosing which plants to curtail is the prices that generators are paid. When supply grows or demand falls, the price of electricity falls. Some generators may decide that they are unwilling to produce electricity below a certain price and drop off if it hits that level.
If there’s still a power surplus, the organization that operates the grid steps in to manually curtail generators. They can either do this through signals in the grid’s data system or by contacting generators directly through phone calls. Power may be curtailed for five minutes or five hours, depending on how quickly the system returns to normal.
Overall, the U.S. needs more low-emissions electricity to help reduce air pollution and slow climate change. So curtailment isn’t a sound long-term strategy for managing power surpluses. It’s somewhat comparable to the early days of the COVID-19 pandemic when supply chain disruptions forced producers to throw away huge quantities of food even as grocery stores struggled to fill their shelves.
One solution is to expand energy storage so that generators can save excess power for a few hours instead of sending it straight into the grid. Another option is building more transmission to carry power to areas that need it. Both types of investments can reduce the need to curtail generation and forgo making clean, affordable electricity.
Fed Chairman Jerome Powell visited the Senate Banking Committee yesterday and will visit the House of Representatives today. Mr. Powell noted that the Fed is “strongly committed” to curbing inflation and pointed out that at this point, the economy is strong enough to withstand the interest rate increases used as a tool to achieve this goal. Powell also said that the pace of future rate hikes would depend on what inflation numbers they see. But the possibility of a recession due to rising interest rates remains. At the same time, a Fed rate hike will not likely result in lower gas or food prices.
Fed spokesman Evans noted yesterday that a 75 basis point rate hike in July is reasonable for discussion and does not see the need for a 100 basis point hike. The odds that the Fed will hike 0.75% again at its next meeting are now nearly 100%. And this scenario is not yet priced in, so analysts expect another wave of declines in stock indices.
At the close of the stock market yesterday, the Dow Jones index (US30) decreased by 0.15%, while the S&P 500 index (US500) lost 0.13%. The NASDAQ Technology Index (US100) fell by 0.15% on Wednesday.
Canada’s Consumer Price Index increased by 1.4% last month (forecast +1%, previous +0.6%). Thus, inflation in Canada has reached 7.7% year on year, which is a record since 1983. Core inflation (which excludes food and fuel prices) rose from 5.8% to 6.3% year/year. Analysts believe Canada’s sharp rise in inflation will reinforce investor expectations for a more aggressive interest rate hike by the Bank of Canada.
Stock markets in Europe mostly traded lower yesterday. German DAX (DE30) decreased by 1.11%, French CAC 40 (FR 40) fell by 0.81%, Spanish IBEX 35 (ES35) lost 1.10%, British FTSE 100 (UK100) closed by 0.88%.
The ECB and Europe’s national central banks have spent three months on the necessary tool to prevent fragmentation that would accompany the slow normalization of European interest rates in response to the rapid rise in inflation, caused partly by the Russian invasion of Ukraine. For now, analysts believe the ECB’s current approach is working. But the ECB’s decision-making discretion is very narrow, not least because of growing political pressure in Germany, France, and Italy.
The UK Consumer Price Index increased to 9.1% year on year (forecast 9.1%, previous 9.0%). Monthly, inflation rose by 0.7%. The last time such a level of inflation was seen was in 1982. Analysts believe the central bank will be forced to take stricter measures at its next meetings.
The head of the Swiss National Bank, Thomas Jordan, indicated yesterday that inflation data shows the need for further monetary policy tightening, but it is unclear when.
Oil fell yesterday as the US plans a tax vacation on gasoline. On Wednesday, Biden said he asked Congress to consider a three-month suspension of the federal gasoline tax of 18.4 cents a gallon and urge states to suspend fuel taxes. The president called on refiners to ensure that all savings were passed on to the American people. The US Energy Secretary Jennifer Granholm will meet with the oil industry today to find ways to lower oil and fuel prices.
Asian markets closed yesterday in the negative territory. Japan’s Nikkei 225 (JP225) decreased by 0.37%, Hong Kong’s Hang Seng (HK50) fell by 2.56%, and Australia’s S&P/ASX 200 (AU200) closed down by 0.23%.
Chinese President Xi Jinping held a summit on Wednesday that endorsed a plan for the healthy development of China’s large payments companies and fintech sector. It could give a boost to tech companies.
Japan’s manufacturing activity growth slowed in June as China’s strict restrictions over COVID-19 affected manufacturing demand, even as service sector sentiment hit a nearly nine-year high. China’s quarantine over COVID-19 disrupted supply chains, severely affecting trade-dependent economies such as Japan.
According to S&P Global, Australia’s global manufacturing PMI increased to 55.8 in June from 55.7 in May. Services business activity fell to 52.6 from 53.2.
Singapore’s Consumer Price Index reached 5.6% y/y (forecast 5.5%, previous 5.4%). The core Consumer Price Index, excluding private fuel and food costs, rose to 3.6% year-on-year (forecast 3.5%, previous 3.3%).
South Korea’s won fell below the psychological level of 1,300 per dollar for the first time in 13 years amid fears of a global economic slowdown.
Main market quotes:
S&P 500 (F) (US500) 3,759.89 −4.90 (−0.13%)
Dow Jones (US30) 30,483.13 −47.12 (−0.15%)
DAX (DE40) 13,144.28 −148.12 (−1.11%)
FTSE 100 (UK100) 7,089.22 −62.83 (−0.88%)
USD Index 104.20 -0.24 (-0.23%)
Important events for today:
– Australia Manufacturing PMI (m/m) at 02:00 (GMT+3);
– Australia Services PMI (m/m) at 02:00 (GMT+3);
– Japan Manufacturing PMI (m/m) at 03:30 (GMT+3);
– Japan Services PMI (m/m) at 03:30 (GMT+3);
– Singapore Consumer Price Index (m/m) at 08:00 (GMT+3);
– Eurozone French Manufacturing PMI (m/m) at 10:15 (GMT+3);
– Eurozone French Services PMI (m/m) at 10:15 (GMT+3);
– Eurozone German Manufacturing PMI (m/m) at 10:30 (GMT+3);
– Eurozone German Services PMI (m/m) at 10:30 (GMT+3);
– Eurozone ECB Economic Bulletin at 11:00 (GMT+3);
– Eurozone Manufacturing PMI (m/m) at 11:00 (GMT+3);
– Eurozone Services PMI (m/m) at 11:00 (GMT+3);
– UK Manufacturing PMI (m/m) at 11:30 (GMT+3);
– UK Services PMI (m/m) at 11:30 (GMT+3);
– Eurozone EU Leaders Summit at 13:00 (GMT+3);
– US Initial Jobless Claims (w/w) at 15:30 (GMT+3);
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
The prices of goods and services are skyrocketing at a pace not seen in several decades, making it more expensive to go about our daily lives.
At the same time, more than 60 central banks around the world have already raised their respective interest rates, and are set to continue doing so for the rest of this year … and beyond.
This combo of red-hot inflation + global policy tightening could ultimately lead to a significant drop in demand/consumption, rising unemployment, and slowing economic growth, or worse, a recession.
What is a recession?
You’ve likely heard this word being used a lot more of late.
We certainly have been using it significantly more in our daily articles.
A popular method to confirm a ‘recession’ = when an economy shrinks for two consecutive quarters. So be on the look out for negative GDP figures.
However, given that GDP figures are backward-looking, such a definition implies that we’ll only know a recession has arrived after it’s happened.
Even the NBER (National Bureau of Economic Research), which is seen as the foremost authority in identifying a ‘recession’ while using a broader range of data, says they can take anywhere from 4 to 21 months before determining that a recession has started.
Also, it’s hard to predict when a recession will happen, though that hasn’t stopped forecasts already being made.
Tesla CEO Elon Musk as well as former New York Fed President Bill Dudley both say a US recession is “inevitable”.
Goldman Sachs places a 30% chance of a recession sometime in 2023, while Deutsche Bank’s CEO, Christian Sewing, and Citigroup analysts think that likelihood is higher at 50%.
Even Fed Chair Jerome Powell just yesterday conceded that a US recession is “certainly a possibility”.
Recession fears are already playing out across global financial markets:
There has been bouts of yield curve inversion – a popular signal for a looming recession.
A yield curve inversion means that investors are more willing to park their money in the safe hands of the US government for longer (e.g. 10 years), for fear of economic turbulence over the shorter-term (e.g. 2 years).
Markets are expecting to see further yield curve inversions in the months ahead.
Risk assets, ranging from stocks to cryptos, have taken a beating! In time of heightened economic uncertainty, investors are a lot less willing to make risky bets.
The S&P 500, an index which is used to measure the overall performance of US stocks, has lost over 20% so far this year, meeting the definition of a ‘bear market’.
The S&P 500 could fall further, potentially testing the low-3000 regions for support.
Even oil has been unwinding some of its stellar gains of late. Investors and traders fear that a recession would mean less consumption/demand for the commodity, hence lower prices.
While fundamental forces (that’s supply and demand) should still suggest that oil can stay elevated, prices could still dip back into sub-$100 levels as traders and investors continue assessing the likelihood of a recession.
Which asset could outperform?
Safe havens are assets that promise to protect one’s wealth in times of great fear.
And gold has time and again proven its worth as a safe haven.
However, before a recession arrives, the Fed wants to send interest rates a lot higher and suck out more money from the economy to help bring down inflation.
Hence, gold could continue languishing in these sub-$1900 levels under the weight of these incoming Fed rate hikes for the rest of 2022, before potentially pushing back higher as the prospects of a recession looms closer.
– Investors need to protect their investments and long-term wealth against soaring inflation and rising interest rates by revising which assets make up their portfolios.
This is the stark warning from Nigel Green, the chief executive and founder of deVere Group, a game-changing global financial advisory organisation.
It comes as retail and institutional investors the world over are battling the economic fallout of soaring consumer prices.
He notes: “Long term and short duration assets respond differently to rising inflation and interest rates.
“Short duration assets include value stocks, such as agriculture, financials, mining and energy sectors. These are the stocks that offer ‘jam today’ for investors, which are popular during periods of volatility as we’re experiencing now.
“Long duration assets, such as long-dated bonds and tech stocks, are particularly vulnerable to rising inflation and interest rate hikes from major western central banks.
“As such, in this volatile environment, investors might need to adjust their portfolios accordingly in order to mitigate risks to their investments and, therefore, their long-term wealth.”
Central banks face a dilemma, says the deVere CEO. Their current aim is to make money more expensive in order to weaken demand and bring down wage growth – “but without causing mass unemployment and triggering a recession.”
When it comes to inflation protection, he says that investors seeking both capital appreciation and capital preservation in this current landscape, should also consider diversifying into less traditional asset classes.
“Rising interest rates, amid weakening business and household demand, is bad news for both bond and stock markets.
“Meanwhile inflation will eat into company profit margins for many companies, particularly those selling discretionary products that businesses and consumers can delay purchasing.
“All this creates market volatility. Investors should consider less familiar, return-enhancing asset classes which could include venture capital, structured products, high dividend stocks, hedge funds and managed futures, and real estate, amongst others. They are also likely to increase diversification and reduce volatility, due to their low correlations to the more traditional investments; and they can hedge some portfolio exposures.
Nigel Green goes on to add: “It is impossible to know how much of the inflation and interest rate story is already baked-in to stock and bond market prices, but investors are anticipating further market volatility.”
The VIX ‘fear gauge’ index of implied future volatility on the S&P500 ended last week at a historically high level of 31.
But investors do appear to have confidence in the U.S. Federal Reserve’s – the world’s most powerful central bank – ability to bring down inflation in the medium term, with the 5yr/5yr forward inflation expectation rate -which measures the average annual inflation rate that is expected over a five year period, commencing in five years- falling over the last fortnight to 2.36% (only a little above the Fed’s 2% target rate).
Portfolio diversification is key, asserts the deVere Group chief executive.
“It’s true that equities have tended to outperform bonds and other assets over the long term. But a broadly diversified portfolio of equities, bonds, commodities and alternatives has performed better on a risk-adjusted basis, meaning after taking into account volatility.”
He concludes: “As ever, bouts of market volatility are the times when most opportunities are presented for investors looking to build long-term wealth.
“That said, investors should consider if they need to revise their portfolios in the current environment.”
About:
deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients. It has a network of more than 70 offices across the world, over 80,000 clients and $12bn under advisement.
“The tidal wave of risk assumption … may be turning”
By Elliott Wave International
On June 14, the yield on the 10-year U.S. Treasury note surpassed 3.45% — its highest level in more than 11 years.
Keep in mind that the lowest intraday reading for the yield on the 10-year note was 0.31% — and that was as recently as 2020. So the rise has been remarkable.
The Elliott Wave Financial Forecast, a monthly publication which provides analysis of major U.S. financial markets, was ahead of this trend reversal. Back in March 2020, the publication showed this graph of yields on global bonds, 10-year U.S. Treasury notes and general obligation municipal bonds. Here’s the commentary:
According to 150 years’ worth of data … this is the first time that 10-year Treasury note yields have dropped below 1%. Grand Supercycle-degree tops set Grand Supercycle records. Investor ebullience is the only thing that allows for an embrace of no-yield debt. The tidal wave of risk assumption, however, may be turning.
In other words: Expect the downward trend in yields to turn upward.
Shortly after that March 2020 analysis in the Elliott Wave Financial Forecast published, yields began to climb.
As you might imagine, bond portfolios have taken a substantial hit (bond prices sink as yields climb).
Shifting to corporate bond portfolios, Bloomberg had this headline on March 14 of this year:
Corporate Bond Rout Is So Severe History Books Need a Revision
The article goes on to say:
[U.S. corporate bond] losses have piled so high that they now belong in history books. A Bloomberg index of investment-grade returns is down 10.5% so far this year … There is little precedent for drops of that magnitude.
Mind you, this was back in March and yields have risen since.
As a May 12 headline from the Associated Press said:
Bonds, haven for elderly and cautious, are getting torched
The question is: What does the Wave Principle say about this rising trend in bond yields?
If you need to brush up on your knowledge of the Wave Principle, an ideal book to read is Frost & Prechter’s Elliott Wave Principle: Key to Market. Here’s a quote from this Wall Street classic:
All waves may be categorized by relative size, or degree. The degree of a wave is determined by its size and position relative to component, adjacent and encompassing waves. Elliott named nine degrees of waves, from the smallest discernible on an hourly chart to the largest wave he could assume existed from the data then available. He chose the following terms for these degrees, from largest to smallest: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Subminuette. Cycle waves subdivide into Primary waves that subdivide into Intermediate waves that in turn subdivide into Minor waves, and so on. The specific terminology is not critical to the identification of degrees, although out of habit, today’s practitioners have become comfortable with Elliott’s nomenclature.
When labeling waves on a graph, some scheme is necessary to differentiate the degrees of waves in the market’s progression. We have standardized a sequence of labels involving numbers and letters … .
If you’re interested in reading the entire book, know that you can gain free access to the online version once you become a member of Club EWI, the world’s largest Elliott wave educational community.
Club EWI is free to join, and members enjoy free access to a wealth of Elliott wave resources on investing and trading.
This article was syndicated by Elliott Wave International and was originally published under the headline 10-Year U.S. Treasury Yield: Anticipating the Rising Trend. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
We are in a double bind right now. Prices are going through the roof but all the signs suggest that the economy is weakening. The answer to higher prices is normally to raise interest rates, but this also induces people and firms to spend less money. The challenge for central banks is to try and deal with both problems at the same time.
We asked three economists whether they saw a way of bringing down inflation without causing a severe recession. Here’s what they said:
Jonathan Perraton, Senior Lecturer in Economics, University of Sheffield
The Bank of England’s decision to raise interest rates by a relatively modest 0.25 percentage points to 1.25% contrasts with the US Federal Reserve’s 0.75 points hike the day before to a range of 1.5% to 1.75%. This reflects concerns in the UK that economic growth will be weaker than previously forecast.
It follows the unexpected news that the UK economy shrank by 0.3% in April, plus sobering forecasts from the Organisation for Economic Co-operation and Development (OECD) that the UK will be the worst performing major economy in 2023 apart from Russia. GDP is now only fractionally above its pre-COVID level and all major sectors are shrinking.
The Bank of England’s caution is despite inflation currently being at 9% and now expected to reach 11% in the coming months. These are levels not seen since the 1980s. Forecasts have the UK experiencing one of the highest inflation rates of the leading economies.
Inflation rates in the G20
Various sources
Inflation is a worldwide problem thanks to pressures on supply chains after COVID and higher energy and other commodity prices following Russia’s invasion of Ukraine. However, US economist Adam Posen has pointed to Brexit as a key factor in explaining Britain’s relatively high inflation. This has meant higher trading costs, weak sterling and labour shortages.
Unemployment has fallen to only 3.8%, although employment rates are still below pre-COVID levels, pointing to more people being inactive – particularly older workers. Staff shortages have become a key feature of the British economy.
You might expect this combination of low unemployment and unfilled vacancies to drive up wages. Instead regular pay, excluding bonuses, fell by 2.2% in real terms in June, the largest fall for over 20 years. So at least this does not yet appear to be a classic wage-price inflationary spiral, where firms give way to demands from workers for higher pay, pass on the costs to consumers in the form of higher prices, and workers demand even higher wages to cope. Having said that, bargaining rounds are yet to be completed and we are seeing more wage disputes in some sectors.
Until now, consumer demand has helped to stimulate economic activity in the UK, but this has partly been sustained by household savings. Some of this reflects households now spending more as COVID restrictions have been lifted but there are clear limits to how far households can dip into their savings as living standards are squeezed. Not surprisingly, consumer confidence is falling.
Longer term problems also remain. UK productivity has been very weak since the 2008 global financial crisis. There are many possible explanations, including weaknesses in capital investment and training – the latter reflected in current difficulties in filling vacancies.
In sum, the Bank of England is facing unprecedented challenges. Interest rate rises are a blunt tool to deal with supply-side problems in a British economy where growth is grinding to a halt. As long as inflation outstrips wages and the economy stagnates, it is likely to fall on the government rather than the Bank of England to provide people with support.
Brigitte Granville, Professor of International Economics and Economic Policy, Queen Mary University of London
Stagflation is upon us, so a natural focus for any “where next?” discussion must be whether we are on course for an episode as bad as the 1970s or even worse. My answer would be that recession is likely, but the 1970s experience of high inflation persisting despite repeated recessions should be avoidable. That said, even a relatively milder dose of stagflation will be painful for living standards.
The mildest way out of the present situation would be inflation promptly curing itself: by making people poorer in real terms so they can’t afford to buy so much. In this scenario, inflation would ease and central banks could help with the downturn in the economy by reversing their present interest-rate hikes.
There are several obstacles to such a fast turnaround, however: the context of the post-COVID recovery and the labour market.
The main inflationary impulse has come from two factors on the global supply side. First, supply chains have struggled to cope with demand collapsing and resurging during and after COVID, made worse by China’s zero-COVID policy. Second, energy and other natural resource supplies have been constrained by Russia’s war in Ukraine and the west’s sanctions.
The inflationary effects of these issues are being prolonged by pent-up demand from western firms and consumers due to COVID stimulus packages in the UK and especially the US, as well as unspent income accumulated during lockdowns. In the UK, for example, household deposit balances were still well above pre-COVID levels as recently as April.
It doesn’t help that the financial markets have been driven to such heights by loose monetary policy. Although the bubbles have been popping recently, valuations will have to fall some way further before people feel poorer and less willing to go out and buy things.
The wealth effect from the long bull market in stocks and other assets won’t peter out overnight.
Turning to the second obstacle to a rapid reversal of the inflation surge, namely the labour market, the main problem again comes from the supply side. Labour demand from firms has normalised post-COVID, but there are too few workers. This is partly to do with more people over 50 choosing not to go back to work, but the UK has the additional problem of Brexit interrupting the flow of good quality labour from central and eastern Europe.
With too few workers, companies are being forced to pay people more – UK wages are rising at about 4% a year – and to pass on the cost to customers in the prices of goods and services. Alert to the threat of a 1970s-style wage-price spiral, the Bank of England has been raising interest rates.
But leading indicators suggest that the wage-price spiral threat is not that serious. The closely watched Purchasing Managers’ Index, which gauges UK companies’ optimism about the economy, shows that those in services are becoming gloomier about the coming months. You don’t keep increasing prices if you think people are going to stop buying. And while we may have seen faint echoes of 1970s-style labour militancy in transport, for instance, pessimistic companies are generally more likely to cut hiring plans and output rather than give way to hefty wage demands – if not shut up shop altogether.
It seems to me that this will be more decisive in determining the course of inflation since it is a long-term structural issue, whereas the post-COVID issues should eventually straighten out. So overall, I expect that the UK economy’s present stagnation, quite likely dipping into mild recession, will bring inflation back down towards the 2% target. In the US, where underlying demand and credit is stronger, sharper interest hikes may be needed to achieve the same goal.
The main danger in my view is central banks becoming too dogmatic about their 2% inflation targets. In my book Remembering Inflation, I reviewed convincing research findings that inflation levels up to 5% cause little or no long-term damage to growth – especially if the inflation rate is steady rather than volatile. So once inflation eases a little, central banks should stop hiking interest rates to avoid doing more harm than good.
Chris Martin, Professor of Economics, University of Bath
The UK labour market is going to be key to how the UK economy performs in the coming months, and its prospects are finely balanced. On one hand, it proved resilient during the pandemic. The furlough schemes were a success, protecting the labour market from the worst effects of the crisis. The fall in employment was around three times lower than in the 1970s, even though the economic contraction was much greater.
Employment also recovered more quickly than in previous recessions. Vacancies are over 50% higher than before the pandemic. Average wages excluding bonuses are rising by about 4% a year, with even higher growth for drivers and workers in construction, software development and warehousing.
On the other hand, employment is still lower than before the pandemic by close to 250,000 workers. Real wages are still no higher than in 2008. And the macroeconomic context is gloomy: it is hard to see how the labour market will thrive if growth is weak or non-existent.
Several factors make the next few months hard to assess. First, unemployment is no longer a useful labour market indicator. Workers are nowadays categorised as employed, unemployed or inactive. Unemployed workers are actively seeking work but the inactive are not. Of the circa 250,000 drop in employed workers since 2019, 80% are inactive; only 20% are now unemployed.
Economists have a much weaker understanding of the inactive than the unemployed. This matters because most people getting hired are from the inactive rather than the unemployed category.
Second, perhaps surprisingly, Brexit has not reduced migration, but it has changed it. There are fewer EU citizens employed in the UK, but more workers from Nigeria, India and similar countries. They tend to be more highly skilled and to work in health and social care, rather than in hospitality.
More skilled workers should be good for productivity and fill vital roles in health and social care, but hospitality is struggling at the same time. However, it is not yet clear if these changes are permanent, and this too makes the labour market more difficult to forecast.
In addition, the behaviour of vacancies and their relationship to hiring seems to have changed. The most recent data shows 1.3 million vacancies, around 40% higher than pre-pandemic. But this has not resulted in record numbers of workers being hired. Whatever the cause, we can no longer rely on high vacancy posting to generate rising employment.
Finally, a striking divide is opening between the public and private sectors. Private sector employment is back to pre-COVID levels, but public sector employment lags behind. Private sector wages are currently increasing by 8%, compared to just 1.5% for the public sector. Forecasting public sector employment is difficult, since it is immune to some of the market forces that drive the private sector, although there seems little prospect of noticeable growth over the next few months.
These negative forces will be offset by the large number of vacancies currently being offered by firms and by relatively large wage rises in some parts of the private sector. This may induce some of those workers back into the labour market who have withdrawn following the pandemic.
On balance, I would expect a fall in employment of up to 100,000 workers in the coming few months. That’s less than 0.1%, so it’s not going to greatly exacerbate all the other problems in the economy.
There wasn’t much dramatic tension as markets waited for the Bank of England’s latest decision on interest rates. The fifth monthly quarter-point hike in a row was largely expected, taking the base rate to 1.25% in June 2022. All the announcement really revealed, in fact, was what a mess UK economic policy is in.
Neither the Bank of England, nor the government, is now helping to deal with Britain’s economic problems. A more rational approach to monetary and fiscal policy is needed.
The Bank’s aim is to curb inflation. But the interest rate rise is unlikely to affect inflation at all. There may be a small impact on import prices, if higher rates prevent a further deterioration in the value of the pound. But raising the rate at which citizens and businesses in the UK can borrow money will not ease the global rise in oil, gas and food prices that is the main source of inflation now.
The Bank of England’s members know this, of course. Their justification for raising rates is that they want to keep inflationary expectations under control, to prevent an uncontrollable “wage-price spiral”. This can happen when expectations of future inflation lead workers to bargain for higher earnings to compensate, which only adds to inflation. The Bank of England’s fear is a return to the 1970s. Such a wage-price spiral pushed inflation to 22.6% in 1975.
But the problem with this argument is that inflation has been more than 4% since October 2021 and real earnings are not rising. Strip out bonuses being paid in a small number of sectors, and wages rose only 4.2% between February and April 2022, which in real terms (once inflation is included) is a fall of 2.2%. And the trend is downwards, not upwards.
In the 1970s, more than half the workforce were members of trade unions, giving them the muscle to bargain for higher wages. Average earnings in 1975 hit almost 30%. Today, fewer than a quarter of employees are union members, and most of these are in the public sector, where wages are currently rising by just 1.5% on average.
So there is little chance of a 1970s-style inflationary wage-price spiral. But these cuts in real wages are already starting to cause a contraction of the UK economy. Consumers have no choice but to spend more on the necessities of energy and food, much of which leaves the UK economy. So they are cutting back on discretionary spending on items such as entertainment and home goods, where more money tends to stay within the UK.
And in this situation, the Bank of England’s rate rise will actually make things worse. As interest rates rise, consumers and businesses will find it more costly to borrow to invest and spend, and aggregate demand will fall further.
Government policy
The government isn’t helping either. The emergency package of support to consumers announced by Chancellor Rishi Sunak in May represents a significant stimulus. But the government’s overall fiscal stance is still contractionary, with significant tax rises acting to withdraw demand from the economy. Sunak is still more intent on limiting public borrowing, in accordance with his self-imposed fiscal rules, than he is on keeping either taxes down or spending up.
So, on the one hand we have the Bank of England raising rates in a way that will not affect inflation, but will curb consumer spending. On the other, the government is simultaneously withdrawing demand from the economy via tax rises. And all while the UK economy is contracting.
It is hard not to see this as anything but an economic policy mess. What the UK needs is much stronger coordination between fiscal and monetary policy. If interest rates are to rise, this should only occur while the government stimulates the economy to ensure output and incomes are sustained.
And underneath all this are much deeper weaknesses in the UK economy, which date from well before COVID-19. The UK has close to the lowest rate of investment, and among the lowest productivity and weakest wage growth of any leading economy. Over the last year, business investment has been falling, deeply affected by Brexit and the overall weak outlook for growth. Productivity fell by 0.7% in the last six months. And the Office for Budget Responsibility forecasts that real wages will still be lower in 2026 than they were in 2008.
The government likes to boast about the UK’s very low unemployment rate, now just 3.8%. The labour market is currently as tight as it has ever been, with more vacancies than there are people officially unemployed. But this disguises the fact that employment has also fallen: half a million people have left the labour market since before the pandemic. Some of these have been EU citizens leaving the country; others have taken early retirement, declared themselves sick, or are unwilling to work on the wages they are being offered.
To return to growth, the UK needs to attract more people into the labour market. This requires higher wages, not lower. It also demands an improvement in labour conditions, particularly in the insecure gig economy of zero hours contracts and precarious self-employment. Making work more attractive would require firms to invest in better equipment and skills training, in turn raising productivity.
In a rational economic policy world, the government would now be brokering sectoral productivity deals with businesses and unions, promising government support in return for higher investment and higher earnings. This could indeed be at the heart of the government’s “levelling up” strategy. But unfortunately, we are not in such a world.
The US stock market did not trade yesterday due to the banking holiday.
Stock markets in Europe traded higher yesterday. German DAX (DE30) gained 1.06%, French CAC 40 (FR40) added 0.64%, Spanish IBEX 35 (ES35) jumped by 1.72%, British FTSE 100 (UK100) was up 1.50% on Monday.
The euro increased on Monday as markets focused on the European Central Bank’s anti-fragmentation tools, ignoring the risk of political gridlock in France after President Emmanuel Macron lost an outright majority in parliamentary elections.
On Monday, ECB President Christine Lagarde confirmed plans to raise ECB interest rates twice this summer, fighting widening spreads in the cost of borrowing by various Eurozone countries.
Germany will restart its coal-fired power plants and introduce an auction scheme to cut gas consumption after Gazprom cut supplies by 60% last week. On Monday the Dutch government said it would lift restrictions on production at coal-fired power plants and activate the first phase of its energy crisis plan.
The situation in the oil market remains the same. Oil markets are keeping oil prices above $105 a barrel. Oil prices rose yesterday as traders focused on limited supplies due to a slowdown in global economic growth. Analysts expect limited production from OPEC+ countries this summer, so market shortages will remain with demand growth.
Asian markets have been trading in positive territory since the opening. Japan’s Nikkei 225 (JP225) increased by 2.26%, Hong Kong’s Hang Seng (HK50) added 1.43%, and Australia’s S&P/ASX 200 (AU200) is up by 1.41% from the opening bell.
The People’s Bank of China left key interest rates unchanged on 1-year and 5-year loans. As the economy continues to face immense challenges, recovery is likely to be slow, with unemployment a key economic problem.
Imports from China’s Xinjiang region will be banned in the US starting today after the new rules take effect. Under the laws, firms will have to prove that imports from the region are not made using forced labor. China has repeatedly denied accusations of holding Uighurs in internment camps in Xinjiang.
Reserve Bank of Australia Governor Lowe has warned that the central bank’s board will do whatever is necessary to bring inflation under control, which he now expects to reach 7% by year’s end, doubling the bank’s 2-3% target. That’s why the RBA was forced to raise the interest rate more than expected by 50 basis points at this month’s board meeting. Economists forecast another 50-basis-point hike in July and possibly another in August, raising the rate to 1.85% by year’s end.
Main market quotes:
S&P 500 (F) (US500) 0 0 (0%)
Dow Jones (US30) 0 0 (0%)
DAX (DE40) 13,265.60 +139.34 (+1.06%)
FTSE 100 (UK100) 7,121.81 +105.56 (+1.50%)
USD Index 104.47 -0.23 (-0.22%)
Important events for today:
– Australia RBA Governor Lowe Speaks at 03:00 (GMT+3);
– Australia RBA Meeting Minutes (m/m) at 04:30 (GMT+3);
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
A sense of normality seems to be returning to financial markets after the brutal selloff in global shares last week. Asian stocks rebounded on Tuesday following the positive cues from European markets overnight while U.S futures moved higher after their markets were closed for a holiday. While the improving sentiment could support equity bulls in the near term, caution lingers in the air with investors likely to adopt a guarded approach towards risky assets.
In the currency arena, the dollar kicked off the week in a shaky fashion while gold waited for another fresh directional catalyst to break out of its current range. Oil prices rose 1% this morning, clawing back more of last week’s steep losses as market players focused on the tight supply dynamics in the commodity.
The week ahead promises to be eventful and potentially volatile thanks to key economic reports from major economies and Fed Chair Jerome Powell’s semi-annual testimony before Congress. Major themes ranging from inflation fears, rate hike expectations, ongoing geopolitical risks, and recession concerns will influence the market mood.
All eyes on Powell’s testimony
Fed Chair Jerome Powell will be under the spotlight this week as he testifies before Congress over two days.
Last week, the Federal Reserve raised interest rates by 75 basis points – its biggest increase since 1994. However, the central bank reassured markets that such jumbo-sized rate hikes would be rare. Powell’s testimony will be closely scrutinised for hints about incoming rate hikes and the outlook for the US economy. Should Powell strike a hawkish note and offer fresh insight into rates, this may boost expectations that the central bank will maintain an aggressive approach towards rates. Traders are pricing in an 89% chance of a 75-basis point rate hike at the next FOMC meeting in July.
Taking a look at the dollar, it has weakened against most G10 currencies this morning. The Dollar Index (DXY) could extend declines if a breakdown below 104.0 is achieved. Alternatively, a move above 104.50 may signal an advance towards 105.00.
Oil prices buoyed by supply worries
Oil prices pushed higher on Tuesday as investors focused on the persistent supply constraints and tightening market conditions. Given how the global commodity remains pulled and tugged by conflicting forces, this could result in more volatility down the road.
On one side of the equation, ongoing geopolitical risks and sanctions on Russian supplies continue to support prices. However, the Fed’s aggressive hawkish stance has fanned concerns of an economic slowdown which will hit the demand outlook. Despite the conflicting forces, oil benchmarks are up almost 50% since the start of the year.
In regard to the technical picture, Brent crude prices remain under pressure after the steep selloff last Friday. A breakdown below $112.00 could encourage a decline towards $104 and $100. A move above $116.00 could inspire a move back towards $120.
Commodity spotlight – Gold
After the explosive volatility last week, gold has kicked off the new week on a calmer note. The lack of momentum suggests that a fresh fundamental spark needs to be brought into the picture to trigger the next major move in gold. Such a catalyst could come in the form of Fed Chair Jerome Powell’s testimony before Congress this week.
Looking at the technical picture, gold prices are trading below the 50, 100, and 200 SMA on the daily charts. Strong support can be found at $1800 and strong resistance at $1900. There seems to be minor support around $1830. A solid breakdown below this level could encourage a decline towards $1800 and $1764. A breakout above $1858 could trigger a move higher towards $1870 and $1900, respectively. Beyond $1900, the first checkpoint can be found at $1920.
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