EXANTE Macro Insights

By Renée Friedman, PhD

The week in summary:

Welcome to Macro Insights #12. This week markets remained somewhat volatile as uncertainty about how many rate rises and/or just how high an initial US rate rise may be, hit investor confidence this past week following Fed Governor Lael Brainard’s signal that the Fed is getting ready to start raising rates in March. However, markets were able to recover some ground by focusing on corporate earnings although the threat of rate rise has hit tech stocks the most. Although equity markets vacillated this past week, US treasury yields jumped to two year highs while German bunds also passed the zero % threshold (before falling back), an indication that inflation remains a significant problem that most central banks, including the ECB,  will have to grapple with this year. 

Producers are still facing materials shortages, transportation bottlenecks, and tightening labour markets in the US and the UK. The labour force participation rate in the US in particular remains stubbornly lower than would normally be expected due to fears around Covid, lack of childcare for some workers, early retirement and people dropping out of the workforce for other reasons.

Over the past week, Brent crude, the global benchmark, rose to its highest since October 2014 as the International Energy Agency (IEA) said the market looks tighter than previously thought, with demand proving resilient to omicron. There was also the attack on the United Arab Emirates (UAE) by Yemen's Houthi group, escalating hostilities between the Iran-aligned group and a Saudi Arabian-led coalition. In addition, a fire temporarily halted flows through an oil pipeline running from Iraq's Kirkuk to the Turkish port of Ceyhan on Tuesday, briefly stopping flows this weekThe market has also been supported by supply shortfalls from the OPEC+ producer group as it has, according to IEA estimates, produced about 800,000 barrels per day (bpd) below its production targets in December. The IEA said that while the oil market could be in a significant surplus in the first quarter of this year, inventories are likely to be well below pre-pandemic levels.

Things to look out for this coming week 

• In Europe on Friday there is ECB President Christine Lagarde’s speech on the global economic outlook at this year’s virtual Davos Forum. There will also be preliminary data on Eurozone consumer confidence for January. On Monday there is French Markit Composite and Markit Services PMI, German Markit Composite PMI, Markit Services PMI and Markit Manufacturing PMI, and Eurozone Markit Service PMI, Markit Composite PMI, and Markit Manufacturing PMI.  On Tuesday is German IFO Business Climate and Expectations data. On Wednesday is French Consumer Confidence data. On Thursday is German GfK consumer confidence data, 
• In the US on Monday look out for the Chicago Fed National Activity Index, Markit Composite PMI, Markit Services PMI, Markit Manufacturing PMI  and the Dallas Fed Manufacturing Index. On Tuesday is Housing price data and Consumer confidence data. On Wednesday is New Home sale data. More importantly, and what will rule the markets all week, is the US Federal Reserve’s interest rate and monetary policy decision statement. On Thursday there will be initial and continuing jobless claims data, Core personal consumption price data, Personal consumption expenditure price data, data on durable goods orders and non-defense capital goods orders, pending home sales data and preliminary GDP data for Q4.  
• In the UK on Friday there is GfK consumer confidence data and Retail sales data.  On Monday is Markit Manufacturing PMI and Markit Services PMI.

Also on 24 January the process for the election of the new Italian president will start. The voting process involves all members of parliament (MPs) from all of the Italian parliament and representatives from regional administrations. This is a total of 1008 “great electors”, who will vote every day until a candidate manages to reach the required majority. This contest will likely pit former head of the ECB, Mario Draghi, against the flamboyant former Prime Minister, 85-year old Silvio Berlusconi with his history of sex scandals and a previous conviction for tax fraud. The outgoing 80-year old president, Sergio Mattarella, has ruled out accepting another seven-year term. Although there are other potential candidates with Communication minister Vittorio Colao,  Justice Minister Marta Cartabia, former head of the Lower House, Pier Ferdinando Casini, and former Prime Minister Romano Prodi. being mentioned, all being mentioned, much will depend on the agreements the different representative parties can come to.

Is the old normal possible?

We are all, quite literally, sick and tired of Covid in all its variant manifestations and desperate to return to our normal, pre-Covid, lives. However, the pandemic and the supply and demand mismatches it both created and exacerbated, along with extensive fiscal transfers by some governments, e.g. The Economist estimates nearly $11 trillion was spent to ensure that Covid effects were transient (The Economist), have togeher ended the era of low global inflation. The inflation expectations  that became ingrained with the advent of extraordinarily loose monetary policy measures that followed from the financial crisis of 2007-09 can no longer be maintained. By attempting to generate inflation, central banks have cut adopted heterodox policies: bringing short-term interest rates to the point that they are negative and expanding balance sheets to levels that would have previously been thought virtually impossible.  However there are growing concerns that  keeping interest rates at historic lows for too long risks rising inflation and excessive borrowing.
Given current inflation rates, markets  are now thinking we are returning to an “old normal”, where central banks use traditional, well-established practises to influence economic growth and maintain financial stability.  The problem now being discussed by market pundits and policy advisors alike is whether the return to the “old normal” is possible given the highly indebted global economy after years of low interest rates; will the withdrawal of liquidity when economies are still recovering from Covid limit growth leading to a higher probability of some form of limited stagflation until productivity dynamics change? 

A reset for a “new normal” interest-rate environment will mean that portfolio asset allocations will need to  be adjusted accordingly, and the extended honeymoon that we’ve experienced over the past decade plus with low rates, during which risk assets outperformed the economy,  will likely end.

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