Few silver linings
View from the Trading Desk:
Now, more than ever, we’d like to paint a positive picture of the UK economy, perhaps something around the corner which would organically cool inflation or some narrative about the strength of the average consumer. Alas, bad news like this morning’s GDP print cannot be spun positively. The story is simple, things will get worse before they get better. An April contraction of 0.3% marked the third consecutive month GDP hasn’t grown, while manufacturing and construction figures also fell. The Pound’s trade-weighted index has now declined more than 2.0% since last Tuesday and looks set to hit its weakest value since September 2020.
Yet, the equation for the Bank of England this week remains simple, rates need to rise in response to red hot inflation, even if that compounds the cost-of-living crisis. Markets are pricing in more than 75bps of BoE hikes for the June and August meetings, raising the chance of a 50bps increase on Thursday. Whether or not the country slips into a technical recession likely doesn’t matter to the average UK consumer. With living standards falling, shattered consumer confidence, and little to no growth, we could be facing one of the bleakest periods in recent memory outside of shock events like the financial crisis or Covid.
Meanwhile, news on the other side of the Atlantic doesn’t read positively either. Friday’s US inflation print hit a fresh 40-year high, prompting markets to bet on 75bps of Federal Reserve rate hikes this week. This will likely only intensify growth worries for the US. Just this morning, we’ve seen an inversion in the two and ten-year Treasury yield curve—historically a relatively decent indication of recession.
Bottom line: While existing economic conditions in developed nations are a major concern for central bankers, they’re a nightmare for politicians. For Boris Johnson, who is already juggling credibility issues, the Northern Ireland Protocol, and a party rebellion, economic turmoil might be the final nail in the coffin.
The week ahead
Sterling struggled yet again last week, with Spot returns placing the currency sixth among the G10 as the US Dollar gained. It’s hard to see any respite for the Pound in the coming weeks as economic data points lower. GDP contracted in April, as manufacturing, services, and construction output all fell for the first time in 18 months. Cable is closing in on its year-to-date low of $1.2156, trading just above the $1.22 handle this morning as growth concerns erode confidence in the UK. Such a slowdown is likely to keep the Bank of England more cautious this Thursday and may point to a hike of 25 basis points with a 2.00% headline rate in the crosshairs by year-end.
- UK Monthly GDP (m/m) for April was published this morning, with the economy contracting 0.3%. Analysts had estimated 0.1% growth.
- Industrial Production m/m also fell by 0.6% in the month of April, despite expectations of a 0.3% print.
- The Bank of England will meet this Thursday to provide its latest Monetary Policy Summary along with its interest rate decision. Markets are expecting a 25-basis-point hike to a headline rate of 1.25%.
- Retail Sales m/m for May will be released this Friday. Markets are pointing to a -0.6% print.
The Euro is down almost 2.50% against the US Dollar in the last week as the European Central Bank moved to hike interest rates in July but failed to address rising bond yields and fragmentation risk. Peripheral economies in the Eurozone are experiencing higher borrowing costs as yield jumps start to outpace more robust economies such as Germany. The spread between Italian and German ten-year government bonds has widened by 233 basis points—the highest since May 2020—as yield rises threaten to tighten financial conditions too much in economically weaker countries. European shares are in the red across the board today, with the DAX falling 2.25%.
- German ZEW Economic Expectations are forecast to rebound to -26.8 in June versus -34.3 in May.
- German Bundesbank President Joachim Nagel is due to speak this Wednesday at 10:15AM.
- European Central Bank President Christine Lagarde will be speaking at the London School of Economics this Wednesday.
- ECOFIN meetings are scheduled to take place all day on Friday.
The US Dollar has been buoyed over the last week following rising inflation, rising bond yields, and consumer sentiment hitting an all-time low. Traders have ramped up bets on more aggressive interest rate hikes by the Federal Reserve since Friday’s inflation data. 175 basis points of hikes are priced in between now and the September meeting, suggesting at least one 0.75% hike. The Fed will likely stick to its current forward guidance and hike 50 basis points this Wednesday, but the focus will be on the language and willingness of the Federal Open Market Committee to move further. S&P 500 futures are down over 2.00% at the time of writing as price pressures continue to weigh on sentiment.
- US Producer Price Index and Core PPI m/m for May are expected to read 0.8% and 0.6%, compared with 0.5% and 0.4% in April.
- Following PPI, Retail, and Core Retail Sales m/m could rise around 0.1% and 0.7% in May, with data due to be released on Wednesday.
- Wednesday evening will see the Federal Reserve announce its latest interest rate decision. We’ll also get an update on the FOMC’s latest economic projections.
- Federal Reserve Chairman Jerome Powell will be speaking in Washington DC on Friday at 1:45PM.
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