Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
Speaker: Join us as we hear from industry leaders and HSBC experts on the latest insights and opportunities for your business.
Speaker: Thank you for listening.
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.
Speaker: Coming up this week, we start in the UK following Boris Johnson's resignation as Conservative Party leader.
Speaker: And then we look at what the latest global data are telling us about the likelihood of a recession in the coming quarters.
Speaker: We examine what a reappraisal of rate expectations could mean for bond yields.
Speaker: We discuss how Europe could get through the winter without Russian gas.
Speaker: And we find out how machine learning can provide useful predictions about the FX market.
Speaker: This podcast was recorded on Thursday, the 7th of July, 2022.
Speaker: Our full disclosures and disclaimers can be found in the link attached to this podcast.
Speaker: Hello, I'm Aline Van Dyne.
Speaker: And I'm James Pomeroy.
Speaker: We're going to start in the UK where there have been quite significant political developments.
Speaker: Boris Johnson has announced his resignation as Conservative Party leader, although he will remain Prime Minister until a new leader is chosen.
Speaker: Simon Wells, our Chief European Economist, can give us some reaction.
Speaker: Simon, it sounds like there is a complicated and potentially long-winded process ahead.
Speaker: That's right, we've seen extraordinary events in UK politics over the past few days.
Speaker: Two senior ministers resigned and that was followed by a deluge of government ministers all resigning.
Speaker: And in the end, Boris Johnson, it seems felt he had no choice but to step down.
Speaker: The question is who will succeed him?
Speaker: And there's no one single obvious candidate.
Speaker: The race is fairly open and that does mean it could take some time.
Speaker: In terms of the timetable, it's still not being announced.
Speaker: It's expected to be announced next week.
Speaker: Normally, what would happen would be names would go forward.
Speaker: The parliamentary party, the MPs, would vote to eliminate candidates until there were only two left.
Speaker: And then those two would go forward to a postal ballot of Conservative Party members.
Speaker: Now, in 2019, that process took around a month.
Speaker: But of course, we're heading into the holiday season.
Speaker: So the question is, can it be done before the summer?
Speaker: And Boris Johnson himself has said he may still remain Prime Minister until October at the time of the Conservative Party conference.
Speaker: So the timescale is uncertain and particularly against the backdrop of the cost of living crisis and global geopolitics.
Speaker: That does leave the UK in a rather interesting state.
Speaker: Simon, you mentioned the challenges facing the UK economy.
Speaker: Does this uncertainty make things trickier?
Speaker: How does it affect the outlook?
Speaker: Well, what we know about the UK economy is whoever the next prime minister is, they're facing big challenges.
Speaker: The UK has a particularly unfavourable growth and inflation mix.
Speaker: We expect inflation will peak above 10 percent in October.
Speaker: and the UK economy hasn't grown since January.
Speaker: Part of the reason for that, of course, is the huge cost of living squeeze on households.
Speaker: And we think real terms incomes could fall 3% this year, which is very large indeed.
Speaker: So of course, there will be a lot of pressure for more fiscal support.
Speaker: The government has already announced quite a lot, but we can potentially think that the new Prime Minister may wish to do more.
Speaker: The
Speaker: problem with that, of course, is rising debt interest costs.
Speaker: Already, we've seen a sharp rise and inflation and interest rates are rising.
Speaker: And that means, given the fairly large debt burden, that debt servicing costs could rise very rapidly.
Speaker: And that will be on the back of the mind of the new Chancellor and Prime Minister.
Speaker: So yes, there are lots of uncertainties, and certainly a big challenge for the UK's new government.
Speaker: Simon, thank you for the update and we'll be hearing more soon, I'm sure.
Speaker: I'm sure we will.
Speaker: Thank you.
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.
Speaker: You've been looking at whether the latest data back this thesis up.
Speaker: So first, why are so many market participants predicting an impending downturn?
Speaker: So lots of risks have clearly risen in the global economy.
Speaker: Inflation rates are staying much more persistent than people were thinking they would.
Speaker: And these high inflation rates are making central banks raise interest rates at a faster pace than we thought they would previously.
Speaker: And there's a possibility we see even higher rates in the months and quarters to come.
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.
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.
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.
Speaker: And when you look through the data, are there any reasons for optimism?
Speaker: There are.
Speaker: And the remarkable thing is at the moment is how steady the macroeconomic data are proving to be.
Speaker: Consumers are still spending.
Speaker: Despite their lack of optimism, they keep spending money.
Speaker: Labour markets are ridiculously tight in most of the world, with the exception of in mainland China.
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.
Speaker: So there is actually an element of room for optimism.
Speaker: There's also a catch up spend that's still happening.
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.
Speaker: So there's actually more room for optimism in the data than you might initially
Speaker: you think?
Speaker: So there is some good news.
Speaker: Can this be sustained?
Speaker: That's the big question.
Speaker: And there's a lot of doubts out there that it can be, particularly some of this labour market data.
Speaker: And given how tight labour markets are, it's almost impossible to tighten any further.
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.
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.
Speaker: That's perfectly plausible.
Speaker: But generally, a lot of this good news has been resilient for quite some time, longer than we would have expected.
Speaker: We've got to keep that in mind, that maybe actually the economy, despite all these negative impacts,
Speaker: risks, could actually keep ticking along a lot longer than economic theory or market participants might typically expect.
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.
Speaker: Bringing all of this together, are we expecting a recession?
Speaker: So our forecasts don't point to a overall global or US recession.
Speaker: What we are thinking about is more of a partial recession.
Speaker: Some parts of the economy doing particularly badly.
Speaker: There's some households who are seeing a big real income squeeze, some sectors who
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.
Speaker: But we also could see some parts of the economy do really, really well.
Speaker: I mentioned tourist spending catching up, some households are seeing positive real wage growth due to the tight labour market.
Speaker: And while some economies face some greater downside risks, we also have some economies that have got some upside
Speaker: upside risks from their reopening and potentially a faster catch up in overseas visitor numbers.
Speaker: So I think there's plenty of reasons for caution, particularly over the next few months.
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.
Speaker: That's a great summary, James.
Speaker: Thank you.
Speaker: Thank you very much.
Speaker: In the fixed income markets, US bond yields have come down from the highs seen in the middle of June.
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.
Speaker: Let's hear from Steve now.
Speaker: This month's fixed income asset allocation comes after a couple of weeks when there's been a strong repricing of rate expectations.
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.
Speaker: So markets have reduced the amount of rate hike expectations that they previously had.
Speaker: This is quite significant because it informs our strategy, particularly on the yield curve.
Speaker: Now, in recent weeks, we've been talking about how the next big move in the yield curve is going to be steeper.
Speaker: And that's a move led by the US.
Speaker: Let's just think through what's behind this.
Speaker: Well, first of all, there was the signal that the curve flattening was moving in the opposite direction to the forwards.
Speaker: The five year, five year forward went really high at a time when the curve was flat and low.
Speaker: This is suggesting the market is feeling for the peak in rates.
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.
Speaker: More fundamentally, you can see support for this in the incoming data.
Speaker: What people have been focusing on is the increasing probability of lower growth and even in some cases the recession risk.
Speaker: That's a shift in narrative away from the persistently high inflation that we had in the first half of 2022.
Speaker: We think there's probably more to it.
Speaker: Markets are also aware, given the longer term structural fundamentals, the rates can't go up that much.
Speaker: That's mainly related to the debt stock that has only gone up since the pandemic.
Speaker: So feeling for a lower peak in rates is becoming a theme for the second half.
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.
Speaker: Russia has cut its gas supply again, this time to the heart of Europe, including to its biggest customer, Germany.
Speaker: So how will Europe get through winter without Russian gas?
Speaker: Kim Fustier, oil and gas analyst, joins us now.
Speaker: Kim, welcome to the podcast.
Speaker: Yeah, thanks for having me here.
Speaker: So, Kim, can you talk us through what exactly Russia has done and what its impact on Europe will be?
Speaker: Sure.
Speaker: So Russia has reduced gas exports to Europe via the Nord Stream 1 pipeline by 60% since mid-June.
Speaker: Gazprom has cited quote-unquote technical issues, but the explanations they've given are unconvincing, to say the least.
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.
Speaker: We find it quite hard to disagree with that assessment.
Speaker: And if we're right, then we should assume the cut is permanent.
Speaker: So this is yet another escalation for Russia.
Speaker: Remember, two months ago, Russia had cut off five European countries, but those were relatively small buyers.
Speaker: And this time they've cut off the heart of Europe.
Speaker: So, you know, Germany, Italy, France, among others.
Speaker: So how can these cuts be offset?
Speaker: Will LNG be able to fill the gap?
Speaker: It's a good question.
Speaker: So far this year, Europe had been doing quite well refilling storage by importing a lot of LNG.
Speaker: And almost all of this incremental LNG going into Europe has come from the US.
Speaker: I mean, incredibly, the US is now supplying more gas to Europe than Russia since June.
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.
Speaker: So refilling European storage ahead of winter will get harder.
Speaker: Now, just for context, filling gas storage is not optional.
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.
Speaker: So that presents, I think, a real challenge for Europe in the months ahead.
Speaker: So what can Europe do to ensure it doesn't run out of gas this winter?
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.
Speaker: Excluding weather effects, we're looking at European consumption down already more than 5% year on year, really because of high prices.
Speaker: Now, we need demand to shrink by more than that.
Speaker: We think about 9% year on year over the next 18 months in order to go through winter.
Speaker: So from 2021 out to 2023, that means removing gas consumption equivalent to the entire demand of a country like Germany.
Speaker: And if price elasticity alone doesn't get there, then we think some countries will need government-imposed rationing of gas.
Speaker: whereby households will be protected and industry gets rationed.
Speaker: And of course, this has big implications for industrial output, GDP, inflation, trade deficits, etc.
Speaker: And Germany is by far the most exposed.
Speaker: You know, Europe's energy crisis is no longer just about high prices.
Speaker: It could potentially morph into outright shortages this winter.
Speaker: It's quite hard to imagine this now because we're still in summer.
Speaker: But then the start of winter is only four months away.
Speaker: The EU's goal is to wean itself off Russian gas by the end of 2027.
Speaker: Do you think this is possible?
Speaker: I mean, just a few months ago, we thought this goal was, you know, unrealistic.
Speaker: We were previously very skeptical and we thought something like this might take a decade or so.
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.
Speaker: Now, what's been happening this year, of course, has not been of Europe's own making.
Speaker: Countries have not been preparing for this, with the one exception of Poland, possibly.
Speaker: So it's been largely involuntary.
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.
Speaker: I think the question is, by 2027, will we have found enough alternatives for this Russian gas?
Speaker: So there will be more LNG by then.
Speaker: And we're also cautiously optimistic we'll manage to accelerate the rollout of alternative energies like renewables.
Speaker: Otherwise, we're looking at potentially a net shrinkage of primary energy consumption in Europe.
Speaker: Kim, thanks so much for the update.
Speaker: Thank you.
Speaker: We finish up this week with a look at the latest work done by our data science team.
Speaker: This week, they've been looking at how machine learning can help predict moves in the FX market.
Speaker: Mark McDonald, head of data science and analytics, joins us.
Speaker: Mark, welcome to the podcast.
Speaker: So your new edition of Data Matters is called the Circle of Strife.
Speaker: What's the piece about?
Speaker: Well, the piece is really about the hidden links between FX and equity markets.
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.
Speaker: And the dollar strength is also causing issues for different companies.
Speaker: I'm having many companies reporting the impact of FX on their results.
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.
Speaker: So let's start with the influence of equity markets on FX.
Speaker: What are you able to say about FX markets from developments in the equity markets?
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.
Speaker: And there are some FX pairs which are well known to be sensitive to changes in risk sentiment.
Speaker: And often when we're looking at that, we use the S&P 500 as a proxy.
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.
Speaker: And it turns out that this works surprisingly well.
Speaker: And I say surprisingly,
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.
Speaker: So it is actually quite surprising to have a model working well in a completely new context that it was not trained for.
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
Speaker: in that market can also be useful for those FX rates.
Speaker: And how are FX markets influencing equities?
Speaker: The strength of the dollar is causing issues for some currencies.
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.
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.
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.
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
Speaker: is the tech sector.
Speaker: And the tech sector is obviously hugely important to US equities and therefore by default to global equities.
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.
Speaker: That's very interesting, Mark.
Speaker: Thanks for talking to us.
Speaker: Thanks for having me on the podcast.
Speaker: So that's all from us today.
Speaker: Thank you to our guests, Simon Wells, Stephen Major, Kim Fustier and Mark McDonald.
Speaker: And James, thank you for stepping in to co-host.
Speaker: No problem, Aline.
Speaker: Thank you to all of you for listening to the podcast.
Speaker: We'll be back again next week.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint Banking and Markets.
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.
