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The Macro Brief – Rate rises on the radar
1 Plays3 seconds ago
Janet Henry, Global Chief Economist, and Simon Wells, Chief European Economist, look at how central banks are set to react to growing upside risks to inflation and downside risks to growth.
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Transcript
Risks and Rate Rises
00:00:00
Speaker
The risks are obviously increasingly skewed towards a greater likelihood of a rate rise rather than a rate cut um in the next year um in the US. And that's added to some of the downward pressure on emerging market currencies. And of course, all of the implications of this conflict are being felt most heavily in parts of Asia.
Introduction to Macro Brief
00:00:29
Speaker
This is the macro brief from HSBC Global Investment Research, where we look at the issues driving financial markets across the world. I'm Piers
Middle East Conflict and Oil Prices
00:00:37
Speaker
Butler. The Middle East conflict has now dragged on for more than two months. And so far, attempts to reopen the critical Strait of Hormuz have been unsuccessful.
00:00:46
Speaker
So with disruption continuing and oil prices staying higher, our economics team have revised some of their key forecasts. Joining me in the studio Janet Henry, global chief economist, and Simon Wells, chief European economist, to tell us about how they're seeing the outlook for growth, inflation and interest
US-Iran Conflict's Economic Impact
00:01:02
Speaker
rates. Janet and Simon, great to have you here.
00:01:04
Speaker
Hi, Piers. Hi, Piers. Janet, if we can start with you, um the U.S.-Iran conflict has dominated the headlines, hit confidence, and yet the impact on activity has been quite modest. Why is that?
00:01:16
Speaker
Good question, Piers. I believe this is week 12 since the the start of the hostilities. And the fact is we we actually have some data for April and we we've had some hard data. Chinese exports were stronger than expected, although its activity was a bit weaker. And elsewhere, we've seen, if anything, some upside surprises to growth, even UK GDP in March and US labour market data.
Supply Shortages and Inflation
00:01:40
Speaker
But I think a lot of what we're seeing at the global level, particularly in those April PMIs that were a lot stronger, it's actually, it's infantry rebuilding has been the major driver. You've actually seen that it's partly the fear of the shortages that might come through. has led um companies particularly to you know rebuild their inventories as much as they can in anticipation perhaps of things getting getting a bit worse.
00:02:05
Speaker
But you think we're closer to to tipping point now what's behind that relative change in in perception? It's simply the duration um of the effective closure of the Strait of Wormuz.
00:02:17
Speaker
I think why you know I feel but feel that we are reaching a new phase um of the implications for the conflict is that reserves are not such high levels. and actually particularly reserves of refined products. We don't have the same kind of inventory data for air fuel and diesel and fertilizers and sulfur, as well as some of the other products, whether it's helium or naphtha and all these other products, um where a large part of them come from the Gulf. um to know exactly when the crunch point will be.
Central Banks and Inflation Challenges
00:02:49
Speaker
But the longer the straight is closed, the greater the likelihood that we do see outright supply shortages. And if we do, you have this competition for scarce resources and the highest payer typically gets gets hold of them. And that can squeeze out other users um of the various products that are available. So that poses upside risk to inflation and downside risks to growth.
00:03:13
Speaker
And indeed, inflation was going to be my next question, Janet. Would it be fair to say that central bankers hadn't quite finished anchoring inflation expectations driven up by the post-COVID price surge before now being confronted by this new challenge? And that makes their task really hard.
00:03:29
Speaker
Well, there are some variations within countries, but I think broadly, there's certainly an element of that. You know, whether we look at, for instance, you know, the ECB or the Bank of England, measures of inflation expectations, households perhaps have reacted quite strongly to this because, you know, the one area we've really seen it on inflation um is on the fuel pump.
00:03:49
Speaker
price. And
Federal Reserve's Inflation Balancing Act
00:03:50
Speaker
we've seen it even in the US and elsewhere that are energy exporters, but where you are still subject to global pricing. and They have learned in recent years that inflation can actually happen.
00:04:01
Speaker
And when central banks haven't met their inflation targets, ah well, Simon talk about the ECB, um But the Fed has not met its inflation target um for five years and on our forecast won't make it in 26 or indeed 27. So yes, I don't think they can take the same risks that they did perhaps in 2022 where they left it too late and ended up having to raise rates a lot more.
00:04:25
Speaker
So just to recap on the US in particular, the Fed's target is 2%. And inflation is currently running at around three? It's heading towards four on a headline inflation, but core PCE is is their main target. but But the Fed is actually a lot more complex because it's not an explicit inflation targeter and they target core PCE, but of course they have a dual mandate. It is inflation, of which broadly they look for around 2% core PCE. And they look for full employment, which you might say is 4.1, 4.2. And unemployment is still at 4.3 because we've had some pretty strong labour market releases out of the US over the course of the last couple of months.
US Interest Rates Outlook
00:05:06
Speaker
So actually, they're not fully meeting either.
00:05:09
Speaker
of their dual mandate at the moment. And probably for now, they still think that they are kind of meeting the fine balancing um of of the two different risks and would look, certainly on our forecast, that they are still set to stay on hold through 2026. But we have been more hawkish than the market um for for many months on the Federal Reserve since well before the conflict, because fiscal support is adding to growth. And, you know, you have got these tax cuts coming through and you've also got some supply constraints even before um the conflict from immigration um and and indeed from tariffs. And I don't believe we've even seen the last um the last of them. but But I still think most likely the Fed stays on hold in 2026.
Asian Interest Rate Adjustments
00:05:54
Speaker
So you say you have been more hawkish, but nevertheless, you still changed some of your forecasts. We absolutely have.
00:06:00
Speaker
The risks um are obviously increasingly skewed towards a greater likelihood of a rate rise rather than a rate cut um in the next year um in the US. And that's added to some of the downward pressure on emerging market currencies. And of course, all of the implications of this conflict are being felt most heavily in parts of Asia.
00:06:20
Speaker
Some countries in Asia have very high level of energy reserves, China in particular, but also the likes of Japan and Korea and Singapore and such like. But some of the poorer um or with less levels of reserves are being more affected, are seeing bigger increases um in inflation. Philippines is one um and potentially a fertilizers and food prices do increase a lot more as they have been because of rice in the Philippines. They'll be raising interest rates um a lot more. That's one we've revised up. And we've also added some rate rise in India and Indonesia um over the course of the last week or two.
Eurozone Economic Conditions
00:06:56
Speaker
So Simon, turning to you and and Europe, perhaps not surprising given what Janice has just ah told us, ah your headline since you published not that long ago in March is now the bad becomes the baseline.
00:07:09
Speaker
What has changed since then to justify that shift in the Eurozone outlook? Yeah, well, March wasn't that long ago, but it feels a while ago, I can tell you, Piers. Well, what's changed is a lot of the things um that that Janet's talked about. We've had this sort of four, five-week moving horizon, at which point the Strait of Hormuz was going to reopen, things were starting would start to get better.
00:07:31
Speaker
That hasn't materialised and as a result the oil prices sort of broadly followed what we had put down for ah the bad scenario back in March. Now the good news for Europe is that the gas price has not. So unlike in 2022 we've not seen anything like the scale of gas price rises which obviously mitigates some of the immediate inflationary impact for the consumer. So we're not quite in the bad scenario as envisaged in March, but we're certainly a lot closer to it than we were to the good scenario. That's been the major change. but That, of course, means higher inflation. That means less income in real terms and weaker growth. And so, yeah, we had to shift.
00:08:15
Speaker
And ah nevertheless, if I look at your inflation forecast, you now expect inflation to peak at just under 4% in September, but you then are forecasting an easing 3.3% in and maybe just explain to us the assumptions behind that easing.
00:08:35
Speaker
it's an It's based broadly on an assumption that the Strait of Hormuz will reopen towards the end of June and normal cargoes will resume towards the end of Q3. And therefore, as a result, energy prices come down and after a year, they drop out of of the annual inflation rate. The key judgment we've made, though, is that there's going to be no wage price second round effects as a result of that initial inflationary impulse. So yes, there will be indirect effects, like Janet's talked about, food and fertiliser and all things like that will have a lingering impact on inflation. um But we're not assuming any kind of yeah wage price spiral as a result of this.
00:09:16
Speaker
And therefore, by the second half of next year, inflation would be below the ECB's 2% target.
European vs. US Wage Pressures
00:09:23
Speaker
I mean, is is Europe more prone to wage pressures than the US?
00:09:28
Speaker
yeah In the sense that the wage bargaining process is more unionised, it's stickier, there's a lot more momentum in European wages, yes.
00:09:39
Speaker
But what we have this time are, I think, three important differences relative to 2022, 2023. The first of those is, as I said, the gas shock is much, much smaller. The second is that back in 2022, we had this global war for talent and the the so-called great resignation combining to reduce the supply and massively increase the demand for labour. So that was putting a lot of upward pressure on wages. And third, of course, policy and monetary policy was way too loose back in 2022. None of those apply this time. So I think the case for those second round effects is smaller.
00:10:15
Speaker
Although I know you're just going to tell me economists never learn their lesson and always tell us it's going to be
Market Optimism and Oil Supply
00:10:20
Speaker
transitory. so But actually on that, Simon, that's a good point. i mean, you also lowered your growth forecasts, didn't you? So slowing demand is part of it. You know, we keep talking about the fact that the upside risks into inflation and the growth risks into the downside. And this is where, you know, some of the the other central banks are informative. You know, Australia is one. They were grappling with higher inflation before the conflict.
00:10:42
Speaker
They've raised rates again um in May, and they are hoping that that's the last because they'll probably see some softening in the labour market and the slowdown in demand will help to slow inflation against these huge supply shocks. So I think that's an important part of your story. as well Absolutely, it is. Yeah. um that And of course, the policy tightening.
00:11:01
Speaker
Which is happening from the markets at the moment with the global bond market route that's underway. Indeed. And I mean, perhaps I can ask a question to both of you. I mean, there is this kind of dichotomy between ah all the all the things you're saying about the economic implications of ah the the war between the US and Iran and the closure of the Strait of Hormuz.
00:11:20
Speaker
and the markets. Is it just that everybody's hoping that the Strait of Hormuz is going to reopen and and therefore they're sort of their assumption regarding the duration of the conflict is still relatively optimistic? And I guess the the rejoinder to that question would be, even if the Strait of Hormuz were to reopen tomorrow,
00:11:39
Speaker
take a while for things to get back to normal, wouldn't it it? certainly would take a while for things to get back to normal. The first thing to flow would be all of those vessels that are still laden with oil. So um the the supply situation eases first on crude oil, so you could still get lag defects of shortages elsewhere that are still feeding through. And even oil, we see a kind of permanent risk premium. We're not permanent, but for the next year or so. And it may take some time for insurance costs and freight costs um to come back down um and to normalize. But
UK's Political and Economic Uncertainty
00:12:10
Speaker
on your point on the markets at the moment, certainly Q1, the earnings season was very, very strong, particularly in the US. It wasn't just the tech sector. It was a broad based. very, very strong earnings report. So as long as they continue to drive that very strong earnings for the next year or two, then maybe they can continue to be supported. But the bond market implication, and particularly in some of Simon's countries, um the the bond market implications is having some impact on on on the real economy through mortgage rates, isn't it, Simon? Yes, absolutely. The pass-through has been very quick. And you've also seen big drops in consumer confidence as well.
00:12:48
Speaker
What about the UK? and is Is the situation even worse because of political uncertainty? Clearly it doesn't help. I mean, Janet has has has mentioned the bond market. Clearly the yeah UK gilt market has been affected by what has been very much a global move, but with this kind of UK kicker on the top, given the additional political uncertainty. So to put it mildly, that tightens financial conditions even further.
00:13:17
Speaker
The UK situation was also not particularly favourable because, and again, Janet mentioned this in the context of the Fed, the Bank of England had not returned UK inflation back to the 2% target, unlike in in in the ECB. And of course, its monetary policy is still probably a bit restrictive, whereas the ECB came into this broadly neutral. So I think what that means is Bank of England's probably going to hike as well, but it's maybe in less of a hurry because, as Janet says, mortgage rates have already tightened. We've got this this gilt market premium as well. So it can afford to wait and probably wait until
00:13:57
Speaker
June, I think even July, before it actually raises
Fed Communication Changes
00:14:02
Speaker
its policy rate. And when it does do so, it may only raise twice, whereas, of course, we're expecting three 25 basis point rises from the ECB.
00:14:10
Speaker
So what's next in terms keeper announcements by central banks? And in addition to that, is the Fed going to be less communicative under its new chairman? Well, certainly um the the new chairman, Kevin Walsh, has indicated that maybe there's a bit too much communication, in his view, from the Federal Reserve, that maybe we will not necessarily see a full press conference at every single meeting. We could go back to having one quarterly. um He is not a fan of the dot plot of these projections of interest rates and um thinks that you shouldn't be providing so much forward guidance, especially when none of us know whether the strait will reopen. tomorrow What are we going to do if we can't study the doc lots anymore? Yes, I think a a lot of what he wants to do and indeed will be able to do, presumably relatively so soon, is on the communications front. Obviously people will be watching and waiting to see how much he influences the committee. um with his views regarding the potential disinflationary forces um of the um of of of this massive AI investment, whether it feeds through into a massive productivity surge, which is disinflationary, and also whether he is able to do anything regarding the size of the balance sheet. when When US yields are at such high levels, arguably, this wouldn't be such a good time to consider um shrinking the US balance sheet.
AI Investment and Economic Effects
00:15:33
Speaker
So I think that one goes on the back burner. for some time. you You mentioned AI productivity. I mean, we've had this conversation before, but as economists, how are you factoring in this impact in terms of productivity in your forecast? I mean, when we first talked about it, it was kind of like emerging, uncertain, what have you, but it's become much more of a reality.
00:15:51
Speaker
What has certainly become a reality is the AI investment surge. And that's become apparent in terms of wealth gains um to the higher earning parts of the population and because of what's been happening to the share prices. It's been evident in global investment, particularly in the US, where it's been growing much, much more rapidly. um than any other area of investment. And it's been evident in world trade. um You've seen massive surge um in AI related global imports. It's accounted for nearly half of the growth in the first half of last year of global trade growth.
00:16:28
Speaker
Have you seen it in productivity yet? I um think the jury is still out um on that one. And it's certainly something that I discussed with Janet Yellen when I record the podcast with her at our at our Global Investment Summit. um Simon, any sign of it in Europe, the productivity upsurge from AI?
00:16:45
Speaker
Not as such. What I would say, of course, is just like what happened in Dotcom One, actually, in the late 90s, is Europe may not have been responsible for a lot of that investment that that you've mentioned, but it did ultimately feel the benefits of them. And you do see, post that period, a rise even in European productivity growth. So there is there is hope out there.
00:17:12
Speaker
Well, we'll have to get you back when those signs start
Conclusion and Engagement
00:17:15
Speaker
to really come through. But for now, thank you very much for joining us. Thank you, Piers. Thanks, Piers.
00:17:24
Speaker
Janet Henry and Simon Wells there on the global economy and central banks, including a trickier outlook for the Eurozone and the UK. If you want to listen to Janet's conversation with Janet Yellen, it's available on HSBC's Global Viewpoint channel.
00:17:38
Speaker
reminder that you can keep up to date on all our latest reports, videos and podcasts by downloading our app from Apple's App Store or Google Play. And while you're there, check out our sister podcast, Under the Banyan Tree, which focuses on Asian economics and markets.
00:17:53
Speaker
And finally, you can get in touch with us at askresearch at hspc.com if you've got any comments or questions. That's it for this week's episode of The Macrobrief, hosted by me, Piers Butler, and produced by Tom Barton.
00:18:07
Speaker
Please like and subscribe wherever you get your podcasts. So until next week, thanks very much for listening.