EXANTE Macro Insights

By Renée Friedman, PhD

The week in summary:

Welcome to Macro Insights #14. This week saw a rise in market performance amidst rising concerns around inflation and growing political risk but markets did not escape unscathed. Tech stocks, which have been bearing the brunt of the market traders fears over how tighter monetary policy would affect valuations. This was compounded this week after the disappointing updates from Facebook owner Meta on Wednesday which sent their shares plunging 22% in early U.S. trading on Thursday on the back of poor earnings results, putting it on track to erase about $195 billion.

Much to no one’s surprise, on Thursday the BoE raised the Bank Rate by 0.25% to 0.5%.  The monetary policy committee (MPC) voted by a majority of 5-4 to increase the Bank Rate. Inflation was 5.4% in December and is anticipated to reach 7.25% by April. In a very interesting sign of just how much inflation is worrying the Bank, those four MPC members wanted to increase the Bank Rate by 0.5 percentage points, to 0.75%. All MPC members said “a modest” tightening would be needed in coming months. In an unanimous vote, the MPC agreed that the Bank of England should begin to reduce the stock of UK government bond purchase by ceasing to reinvest maturing assets. This should allow more than £200 billion to run off  the balance sheet by 2025. The MPC also unanimously voted to reduce the stock of sterling non-financial investment-grade corporate bond purchases by ceasing to reinvest maturing assets and by a programme of corporate bond sales to be completed no earlier than towards the end of 2023. This should offload the entire £20 billion pound stock of corporate bonds. The Bank’s latest forecast shows that UK GDP growth is expected to slow with the main reason being the impact of higher global energy and tradable goods prices on UK real aggregate income and spending. As a result, the unemployment rate is expected to rise to 5%. 

The European Central Bank (ECB) on Thursday decided not to change the policy it agreed to in December despite inflation reaching  5.1% across the Eurozone in January.In its statement it said “the first quarter of 2022, the Governing Council is conducting net asset purchases under the PEPP at a lower pace than in the previous quarter and it will discontinue net asset purchases under the PEPP at the end of March 2022. The Governing Council intends to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2024.” There was no change in rates. The statement continued with “the Governing Council expects net purchases to end shortly before it starts raising the key ECB interest rates.” The ECB said it intends to continue reinvesting the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates, “for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.” Making only the smallest change to its December statement, the ECB removed a clause stipulating that its next policy move could be in "either direction". Markets already doubt the ECB projections about inflation dissipating and, according to Refinitiv estimates, are pricing in 28 basis points of rate hikes this year, despite the bank's insistence that any move in 2022 is very unlikely as the central bank is currently not seeing any secondary effects such as  an increase in wages despite the output gap closing and there being less slack in the broader Eurozone economy. 

On Wednesday OPEC and its allies agreed to make another modest output increase in March with its revival of its previous agreement to increase production by 400,000 barrels a day. However, previous promises have fallen short. OPEC + increased production by only 50,000 barrels a day in January as slight gains across the group were wiped out by a 140,000 barrel-a-day decline in Libya. Add to this the growing concerns about the increasing war of words between Russia and the US over the Russia-Ukraine border issues, the ongoing threats to the United Arab Emirates from Yemen's Houthi militant group which forced the UAE air force to intercept and destroy a ballistic missile launched by the Houthis on 31 January, the ongoing dispute between Morocco and Algeria, and freezing weather in the US which is pushing up oil demand there as well as hitting supply. Oil futures are rising, currently standing at about $90/barrel. This will feed into inflation, worsening growth prospects for energy importing countries which will likely be compounded by central banks in those countries having to raise rates and reduce liquidity.  

This past Monday the IMF warned that the sharp price swings in cryptocurrencies poses “immediate and acute risks” to emerging markets. It is urging national and global regulators to establish a co-ordinated, consistent and comprehensive approach to supervising cryptocurrencies. The IMF points to stability risks due to increasing signs of closer correlation risk between the performance of cryptocurrencies and other financial assets in developed markets. This may also affect emerging markets through investor portfolio holdings being suddenly shifted, affecting the value and price of some EM assets. 

According to the Financial Times, officials at the IMF believe that sharp deleveraging episodes in cryptocurrencies are feeding into sell-offs in equity markets.

Things to look out for this coming week 

• In Europe on Friday look out for German factory orders, French non farm payroll and industrial output data, and Eurozone retail sales data. On Monday there is German industrial production data while on Tuesday Italian retail sales data. On Wednesday there is the German trade balance, which will be an indicator of German growth. On Thursday the European Commission will release its economic growth forecast.
• In the US on Friday there is average hourly earnings data, labour force participation rate information, non-farm payrolls, the unemployment rate and the underemployment rate data.  On Thursday is CPI data, initial jobless claims, and continuing jobless claims. There will also be the monthly budget statement. The deadline for the 2022 budget is 18 February and at present, it seems Congressional negotiators may miss this deadline for passing an omnibus package of the annual appropriations. There is continuing disagreement over President Biden’s “build back better” plan and, if a budget is not agreed to by that point, he may have missed his chance to define the nation’s spending priorities while Democrats control both branches of Congress (Democrats are currently expected to lose their majority in the House of Representatives during the midterm elections in November). The major sticking point seems to be over how much to increase funding for domestic nondefense social programs compared to the military spending. 
• In the UK on Friday is Markit Construction PMI. On Wednesday there is the BRC like-for-like retail sales data.  On Thursday the National Institute for Economic Research (NIESR) will release its 3 month GDP estimate. 

The problem of debt and Emerging markets

A report published by the Jubilee Debt Campaign (EM debt) highlighted that developing countries’ debt payments rose 120% between 2010 and 2021, and are currently at their highest since 2001. The average portion of government revenues channelled toward external debt payments increased from 6.8% in 2010 to 14.3% in 2021, with payments shooting up in 2020.

As noted by Kristalina Georgieva, managing director of the International Monetary Fund, during this year’s virtual Davos meeting, “ interest rate hikes by the Federal Reserve could “throw cold water” on already weak economic recoveries in certain countries.”  And those recoveries could  continue to be affected by persisting vaccine inequality. As noted by Mohamed El-Erian (The winter of our discomfort), the door will remain open to the emergence of new variants until the global population has been generally immunised. Covid could continue to affect developed  economies, through supply chain constraints and commodity shortages.

Can EMs still offer diversification benefits to investors?  

Although yields in developed markets are expected to rise as key central banks like the Fed, the Bank of England, and potentially even the ECB (if inflation continues at current rates) tighten monetary policy, the market situation may not be the same across all EMs. It is clear that some EMs are in a stronger position than they were in 2013 (the last big taper)  in terms of being able to weather the tightening of US monetary policy.  Commodity exporters and countries where the number of Covid cases is relatively low (with the exception of China as it’s zero-Covid policy may negatively affect its growth rate and tie up global supply chains further) are probably in a better position. However countries, particularly those in Latin America, which are seeing weaker growth, higher and more frequent interest rate hikes despite macroeconomic conditions being weak, and that may not be as integral to global supply chains, may suffer. And, given that inflation is expected to be higher for longer across the globe, all EMs, regardless of their debt load,  will face harsher external financial conditions regardless of their own monetary policy cycles, which will limit their ability to manoeuvre. 

This means that the countries with rising debt may find themselves struggling; those with very large external funding requirements and a debt stock with shorter maturities are particularly at risk if there is any sudden shift in external financing conditions.  The consequence for financial market players is that when it comes to EM they should look to allocate to countries that are well placed to withstand Fed tapering and dollar strengthening and that combine commodity exports with strong balance sheets.

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