Become a Creator today!Start creating today - Share your story with the world!
Start for free
00:00:00
00:00:01
The Macro Viewpoint - UK upheaval, recession risks, bond yields, Europe’s gas challenge, Data Matters
18 Plays2 years ago
We assess political developments in the UK, the likelihood of a global recession, what’s next for yield curves, and whether Europe can cope without Russian gas. All this, plus a special focus on how machine learning can produce signals for G10 FX. Disclaimer. To stay connected and to access free to view reports and videos from HSBC Global Research click here
Hosted on Acast. See acast.com/privacy for more information.
Recommended
Transcript
Introduction to HSBC Global Viewpoint
00:00:00
Speaker
This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
00:00:09
Speaker
Join us as we hear from industry leaders and HSBC experts on the latest insights and opportunities for your business.
00:00:17
Speaker
Thank you for listening.
00:00:22
Speaker
You're listening to the HSBC Global Research Macro Viewpoint, our weekly review of the key reports from our economists and strategists across the globe.
00:00:32
Speaker
Coming up this week, we start in the UK following Boris Johnson's resignation as Conservative Party leader.
00:00:39
Speaker
And then we look at what the latest global data are telling us about the likelihood of a recession in the coming quarters.
00:00:46
Speaker
We examine what a reappraisal of rate expectations could mean for bond yields.
00:00:50
Speaker
We discuss how Europe could get through the winter without Russian gas.
00:00:55
Speaker
And we find out how machine learning can provide useful predictions about the FX market.
00:01:00
Speaker
This podcast was recorded on Thursday, the 7th of July, 2022.
00:01:05
Speaker
Our full disclosures and disclaimers can be found in the link attached to this podcast.
Boris Johnson's Resignation and Political Implications
00:01:11
Speaker
Hello, I'm Aline Van Dyne.
00:01:13
Speaker
And I'm James Pomeroy.
00:01:15
Speaker
We're going to start in the UK where there have been quite significant political developments.
00:01:20
Speaker
Boris Johnson has announced his resignation as Conservative Party leader, although he will remain Prime Minister until a new leader is chosen.
00:01:28
Speaker
Simon Wells, our Chief European Economist, can give us some reaction.
00:01:33
Speaker
Simon, it sounds like there is a complicated and potentially long-winded process ahead.
00:01:39
Speaker
That's right, we've seen extraordinary events in UK politics over the past few days.
00:01:44
Speaker
Two senior ministers resigned and that was followed by a deluge of government ministers all resigning.
00:01:50
Speaker
And in the end, Boris Johnson, it seems felt he had no choice but to step down.
00:01:57
Speaker
The question is who will succeed him?
00:01:59
Speaker
And there's no one single obvious candidate.
00:02:02
Speaker
The race is fairly open and that does mean it could take some time.
00:02:08
Speaker
In terms of the timetable, it's still not being announced.
00:02:11
Speaker
It's expected to be announced next week.
00:02:14
Speaker
Normally, what would happen would be names would go forward.
00:02:18
Speaker
The parliamentary party, the MPs, would vote to eliminate candidates until there were only two left.
00:02:25
Speaker
And then those two would go forward to a postal ballot of Conservative Party members.
00:02:31
Speaker
Now, in 2019, that process took around a month.
00:02:33
Speaker
But of course, we're heading into the holiday season.
00:02:36
Speaker
So the question is, can it be done before the summer?
00:02:39
Speaker
And Boris Johnson himself has said he may still remain Prime Minister until October at the time of the Conservative Party conference.
00:02:47
Speaker
So the timescale is uncertain and particularly against the backdrop of the cost of living crisis and global geopolitics.
00:02:55
Speaker
That does leave the UK in a rather interesting
UK Economic Challenges and Leadership Solutions
00:02:59
Speaker
state.
00:02:59
Speaker
Simon, you mentioned the challenges facing the UK economy.
00:03:03
Speaker
Does this uncertainty make things trickier?
00:03:05
Speaker
How does it affect the outlook?
00:03:07
Speaker
Well, what we know about the UK economy is whoever the next prime minister is, they're facing big challenges.
00:03:13
Speaker
The UK has a particularly unfavourable growth and inflation mix.
00:03:18
Speaker
We expect inflation will peak above 10 percent in October.
00:03:22
Speaker
and the UK economy hasn't grown since January.
00:03:26
Speaker
Part of the reason for that, of course, is the huge cost of living squeeze on households.
00:03:30
Speaker
And we think real terms incomes could fall 3% this year, which is very large indeed.
00:03:37
Speaker
So of course, there will be a lot of pressure for more fiscal support.
00:03:40
Speaker
The government has already announced quite a lot, but we can potentially think that the new Prime Minister may wish to do more.
00:03:49
Speaker
The
00:03:50
Speaker
problem with that, of course, is rising debt interest costs.
00:03:55
Speaker
Already, we've seen a sharp rise and inflation and interest rates are rising.
00:04:00
Speaker
And that means, given the fairly large debt burden, that debt servicing costs could rise very rapidly.
00:04:06
Speaker
And that will be on the back of the mind of the new Chancellor and Prime Minister.
00:04:11
Speaker
So yes, there are lots of uncertainties, and certainly a big challenge for the UK's new government.
00:04:20
Speaker
Simon, thank you for the update and we'll be hearing more soon, I'm sure.
00:04:25
Speaker
I'm sure we will.
00:04:25
Speaker
Thank you.
00:04:29
Speaker
Now over to you, James, and the question of whether recession is inevitable soon, if not globally, at least in the US or the Eurozone.
Global Inflation and Consumer Confidence
00:04:38
Speaker
You've been looking at whether the latest data back this thesis up.
00:04:42
Speaker
So first, why are so many market participants predicting an impending downturn?
00:04:48
Speaker
So lots of risks have clearly risen in the global economy.
00:04:51
Speaker
Inflation rates are staying much more persistent than people were thinking they would.
00:04:55
Speaker
And these high inflation rates are making central banks raise interest rates at a faster pace than we thought they would previously.
00:05:02
Speaker
And there's a possibility we see even higher rates in the months and quarters to come.
00:05:06
Speaker
And all of that together makes people a little bit nervous that we could start to see a sharper downturn in some of the economic data.
00:05:13
Speaker
And the start of this has really come from a decline in consumer confidence, which given this cost of living squeeze in most of the world, consumer confidence indicators have fallen very, very quickly.
00:05:23
Speaker
So a combination of these things are starting to make market participants particularly nervous and thinking that a downturn might be on the horizon.
00:05:30
Speaker
And when you look through the data, are there any reasons for optimism?
00:05:35
Speaker
There are.
00:05:36
Speaker
And the remarkable thing is at the moment is how steady the macroeconomic data are proving to be.
00:05:41
Speaker
Consumers are still spending.
00:05:43
Speaker
Despite their lack of optimism, they keep spending money.
00:05:47
Speaker
Labour markets are ridiculously tight in most of the world, with the exception of in mainland China.
00:05:53
Speaker
And that in itself is acting as a bit of a buffer to the economy and stopping a collapse in spending and stopping all of these, as many of these downside risks manifesting them as they could.
00:06:04
Speaker
So there is actually an element of room for optimism.
00:06:07
Speaker
There's also a catch up spend that's still happening.
00:06:10
Speaker
We're seeing this in a lot of the Asian data as economies are reopening, but also in a lot of tourism data and services spending, those numbers that are coming back quite quickly.
00:06:19
Speaker
So there's actually more room for optimism in the data than you might initially
00:06:23
Speaker
you think?
Economic Optimism Amidst Global Risks
00:06:24
Speaker
So there is some good news.
00:06:25
Speaker
Can this be sustained?
00:06:27
Speaker
That's the big question.
00:06:29
Speaker
And there's a lot of doubts out there that it can be, particularly some of this labour market data.
00:06:33
Speaker
And given how tight labour markets are, it's almost impossible to tighten any further.
00:06:38
Speaker
But also, if we were to start to see a turnaround in some of those labour market prints, I think it's very easy to get quite downbeat quite quickly, because suddenly, this anchor to a lot of the economic data could dissipate.
00:06:49
Speaker
There's also some risks around the industrial cycle that we could see some continued weakness in some of the goods production data and good spending data.
00:06:57
Speaker
That's perfectly plausible.
00:06:59
Speaker
But generally, a lot of this good news has been resilient for quite some time, longer than we would have expected.
00:07:05
Speaker
We've got to keep that in mind, that maybe actually the economy, despite all these negative impacts,
00:07:10
Speaker
risks, could actually keep ticking along a lot longer than economic theory or market participants might typically expect.
00:07:18
Speaker
So some reasons for caution about some of this good news, but also some reasons to expect that it could carry on longer than we think.
00:07:25
Speaker
Bringing all of this together, are we expecting a recession?
00:07:29
Speaker
So our forecasts don't point to a overall global or US recession.
00:07:34
Speaker
What we are thinking about is more of a partial recession.
00:07:37
Speaker
Some parts of the economy doing particularly badly.
00:07:40
Speaker
There's some households who are seeing a big real income squeeze, some sectors who
00:07:44
Speaker
who are seeing consumer spending in that part of the economy dry up quite considerably, partly because of weaker income growth, but also because of some of the change in spending habits.
00:07:54
Speaker
But we also could see some parts of the economy do really, really well.
00:07:58
Speaker
I mentioned tourist spending catching up, some households are seeing positive real wage growth due to the tight labour market.
00:08:04
Speaker
And while some economies face some greater downside risks, we also have some economies that have got some upside
00:08:10
Speaker
upside risks from their reopening and potentially a faster catch up in overseas visitor numbers.
Forecasts on Global Recession Risks
00:08:16
Speaker
So I think there's plenty of reasons for caution, particularly over the next few months.
00:08:21
Speaker
But it's also worth keeping in mind, there's still some upside risks in some parts of the world and some parts and some places, even though there are some downside risks, they don't necessarily need to manifest themselves.
00:08:33
Speaker
That's a great summary, James.
00:08:34
Speaker
Thank you.
00:08:35
Speaker
Thank you very much.
US Economic Factors and Rate Expectations
00:08:39
Speaker
In the fixed income markets, US bond yields have come down from the highs seen in the middle of June.
00:08:43
Speaker
And in his latest report, Stephen Major, Global Head of Fixed Income Research, has been looking at what a reappraisal of rate expectations could mean for yield curves.
00:08:52
Speaker
Let's hear from Steve now.
00:08:54
Speaker
This month's fixed income asset allocation comes after a couple of weeks when there's been a strong repricing of rate expectations.
00:09:05
Speaker
So from the June FOMC meeting, which is barely three weeks ago, the expectations for Fed funds by the end of 2023 have adjusted by 100 basis points.
00:09:19
Speaker
So markets have reduced the amount of rate hike expectations that they previously had.
00:09:26
Speaker
This is quite significant because it informs our strategy, particularly on the yield curve.
00:09:33
Speaker
Now, in recent weeks, we've been talking about how the next big move in the yield curve is going to be steeper.
00:09:40
Speaker
And that's a move led by the US.
00:09:44
Speaker
Let's just think through what's behind this.
00:09:47
Speaker
Well, first of all, there was the signal that the curve flattening was moving in the opposite direction to the forwards.
00:09:55
Speaker
The five year, five year forward went really high at a time when the curve was flat and low.
00:10:01
Speaker
This is suggesting the market is feeling for the peak in rates.
00:10:06
Speaker
The likelihood is, and based on previous experiences of this episode, the likelihood is the next big move in the yield curve is steeper.
00:10:17
Speaker
More fundamentally, you can see support for this in the incoming data.
00:10:22
Speaker
What people have been focusing on is the increasing probability of lower growth and even in some cases the recession risk.
00:10:31
Speaker
That's a shift in narrative away from the persistently high inflation that we had in the first half of 2022.
00:10:40
Speaker
We think there's probably more to it.
00:10:42
Speaker
Markets are also aware, given the longer term structural fundamentals, the rates can't go up that much.
00:10:51
Speaker
That's mainly related to the debt stock that has only gone up since the pandemic.
00:10:57
Speaker
So feeling for a lower peak in rates is becoming a theme for the second half.
00:11:04
Speaker
And if we're right, yields will settle at a lower level than they currently are now by year end, and curves will move into a steepening path.
Europe's Energy Crisis Due to Russian Gas Supply Cuts
00:11:17
Speaker
Russia has cut its gas supply again, this time to the heart of Europe, including to its biggest customer, Germany.
00:11:24
Speaker
So how will Europe get through winter without Russian gas?
00:11:27
Speaker
Kim Fustier, oil and gas analyst, joins us now.
00:11:31
Speaker
Kim, welcome to the podcast.
00:11:34
Speaker
Yeah, thanks for having me here.
00:11:35
Speaker
So, Kim, can you talk us through what exactly Russia has done and what its impact on Europe will be?
00:11:41
Speaker
Sure.
00:11:41
Speaker
So Russia has reduced gas exports to Europe via the Nord Stream 1 pipeline by 60% since mid-June.
00:11:48
Speaker
Gazprom has cited quote-unquote technical issues, but the explanations they've given are unconvincing, to say the least.
00:11:55
Speaker
Many European leaders and the head of the International Energy Agency have been on record saying that they suspect the reasons for the cuts are political.
00:12:03
Speaker
We find it quite hard to disagree with that assessment.
00:12:06
Speaker
And if we're right, then we should assume the cut is permanent.
00:12:10
Speaker
So this is yet another escalation for Russia.
00:12:12
Speaker
Remember, two months ago, Russia had cut off five European countries, but those were relatively small buyers.
00:12:18
Speaker
And this time they've cut off the heart of Europe.
00:12:21
Speaker
So, you know, Germany, Italy, France, among others.
00:12:25
Speaker
So how can these cuts be offset?
00:12:28
Speaker
Will LNG be able to fill the gap?
00:12:31
Speaker
It's a good question.
00:12:33
Speaker
So far this year, Europe had been doing quite well refilling storage by importing a lot of LNG.
00:12:38
Speaker
And almost all of this incremental LNG going into Europe has come from the US.
00:12:44
Speaker
I mean, incredibly, the US is now supplying more gas to Europe than Russia since June.
00:12:49
Speaker
Now, the problem is it's going to get harder to offset the loss of Russian gas because of how much Russian gas flows have collapsed since mid-June and because a large US facility has gone offline for four months since the beginning of June.
00:13:05
Speaker
So refilling European storage ahead of winter will get harder.
00:13:09
Speaker
Now, just for context, filling gas storage is not optional.
00:13:13
Speaker
We have to do it because Europe relies on storage withdrawals for about 30% of its gas consumption in the middle of winter when demand is seasonally much higher than in summer.
00:13:24
Speaker
So that presents, I think, a real challenge for Europe in the months ahead.
00:13:28
Speaker
So what can Europe do to ensure it doesn't run out of gas this winter?
00:13:33
Speaker
So really, if Russian flows don't go back to normal, and frankly, I wouldn't really count on it, the only solution is to shrink demand.
00:13:40
Speaker
Excluding weather effects, we're looking at European consumption down already more than 5% year on year, really because of high prices.
00:13:49
Speaker
Now, we need demand to shrink by more than that.
00:13:51
Speaker
We think about 9% year on year over the next 18 months in order to go through winter.
00:13:58
Speaker
So from 2021 out to 2023, that means removing gas consumption equivalent to the entire demand of a country like Germany.
00:14:08
Speaker
And if price elasticity alone doesn't get there, then we think some countries will need government-imposed rationing of gas.
00:14:15
Speaker
whereby households will be protected and industry gets rationed.
00:14:19
Speaker
And of course, this has big implications for industrial output, GDP, inflation, trade deficits, etc.
00:14:27
Speaker
And Germany is by far the most exposed.
00:14:29
Speaker
You know, Europe's energy crisis is no longer just about high prices.
00:14:33
Speaker
It could potentially morph into outright shortages this winter.
00:14:36
Speaker
It's quite hard to imagine this now because we're still in summer.
00:14:41
Speaker
But then the start of winter is only four months away.
00:14:43
Speaker
The EU's goal is to wean itself off Russian gas by the end of 2027.
00:14:49
Speaker
Do you think this is possible?
00:14:51
Speaker
I mean, just a few months ago, we thought this goal was, you know, unrealistic.
00:14:55
Speaker
We were previously very skeptical and we thought something like this might take a decade or so.
00:15:00
Speaker
But given recent events and the EU's very strong determination to make it happen, we think we're well on track to meet this target.
00:15:08
Speaker
Now, what's been happening this year, of course, has not been of Europe's own making.
00:15:13
Speaker
Countries have not been preparing for this, with the one exception of Poland, possibly.
00:15:17
Speaker
So it's been largely involuntary.
00:15:20
Speaker
So oddly enough, we are on track to meet this target, but only because Russian flows are down 50% on average and down two thirds on an exit rate basis.
00:15:30
Speaker
I think the question is, by 2027, will we have found enough alternatives for this Russian gas?
00:15:35
Speaker
So there will be more LNG by then.
00:15:37
Speaker
And we're also cautiously optimistic we'll manage to accelerate the rollout of alternative energies like renewables.
00:15:44
Speaker
Otherwise, we're looking at potentially a net shrinkage of primary energy consumption in Europe.
00:15:52
Speaker
Kim, thanks so much for the update.
00:15:54
Speaker
Thank you.
Machine Learning in Financial Market Analysis
00:15:57
Speaker
We finish up this week with a look at the latest work done by our data science team.
00:16:01
Speaker
This week, they've been looking at how machine learning can help predict moves in the FX market.
00:16:06
Speaker
Mark McDonald, head of data science and analytics, joins us.
00:16:09
Speaker
Mark, welcome to the podcast.
00:16:11
Speaker
So your new edition of Data Matters is called the Circle of Strife.
00:16:15
Speaker
What's the piece about?
00:16:16
Speaker
Well, the piece is really about the hidden links between FX and equity markets.
00:16:22
Speaker
And really, it's the circle of strife is this issue that as we get a risk off period, then not only do risk on currency pairs sell off, but the dollar strengthens.
00:16:33
Speaker
And the dollar strength is also causing issues for different companies.
00:16:38
Speaker
I'm having many companies reporting the impact of FX on their results.
00:16:45
Speaker
And so there's a danger that two markets get into this circle of strife where one exacerbates the other and then that exacerbates the original problem.
00:16:54
Speaker
So let's start with the influence of equity markets on FX.
00:16:57
Speaker
What are you able to say about FX markets from developments in the equity markets?
00:17:01
Speaker
Well, in the data science team over the last few years, we've built several predictive machine learning models which can predict the direction in which specific assets are going to move.
00:17:12
Speaker
And there are some FX pairs which are well known to be sensitive to changes in risk sentiment.
00:17:19
Speaker
And often when we're looking at that, we use the S&P 500 as a proxy.
00:17:24
Speaker
And so in the data matters piece, what we've done is we've looked at, can we use the predictions of our US equity pullback model, which predicts how likely is it that equity markets in the US are going to fall, and use that to generate signals for risk on currencies.
00:17:41
Speaker
And it turns out that this works surprisingly well.
00:17:45
Speaker
And I say surprisingly,
00:17:46
Speaker
because often machine learning models, they typically work best when you give them a narrow task to learn and that the narrower the task, the better they generally work.
00:17:56
Speaker
So it is actually quite surprising to have a model working well in a completely new context that it was not trained for.
00:18:04
Speaker
But I think what happens is that these currency pairs, if risk generally, and say the S&P 500 as a proxy, is an important driver for a currency pair, then being able to predict risk
00:18:15
Speaker
in that market can also be useful for those FX rates.
00:18:19
Speaker
And how are FX markets influencing equities?
00:18:22
Speaker
The strength of the dollar is causing issues for some currencies.
00:18:26
Speaker
And generally what you find is that companies, they're more likely to highlight when currencies have hit their results than when currencies have been a benefit to their results.
00:18:40
Speaker
But we're seeing definitely an uptick in the degree to which companies are warning about the impact of FX on their reported results.
00:18:49
Speaker
And so we look at this aggregated at sector level and at sector level, a lot of the variation can be explained by the foreign revenue exposure, the degree of foreign revenue exposure of companies within that sector.
00:19:02
Speaker
And the real standouts on both metrics, the degree to which they're warning about the impact of FX on their results, on their earnings calls and the high level of foreign revenue exposure
00:19:17
Speaker
is the tech sector.
00:19:18
Speaker
And the tech sector is obviously hugely important to US equities and therefore by default to global equities.
00:19:26
Speaker
And so when these companies are starting to run into headwinds from the strong dollar, then this raises the risk that potentially this could be a further headwind to equities and risk more generally going forward.
00:19:41
Speaker
That's very interesting, Mark.
00:19:42
Speaker
Thanks for talking to us.
00:19:44
Speaker
Thanks for having me on the podcast.
00:19:46
Speaker
So that's all from us today.
00:19:49
Speaker
Thank you to our guests, Simon Wells, Stephen Major, Kim Fustier and Mark McDonald.
00:19:54
Speaker
And James, thank you for stepping in to co-host.
00:19:58
Speaker
No problem, Aline.
00:19:59
Speaker
Thank you to all of you for listening to the podcast.
00:20:01
Speaker
We'll be back again next week.
00:20:07
Speaker
Thank you for listening today.
00:20:09
Speaker
This has been HSBC Global Viewpoint Banking and Markets.
00:20:13
Speaker
For more information about anything you heard in this podcast or to learn about HSBC's global services and offerings, please visit gbm.hsbc.com.