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 team of economists and strategists across the globe.
Speaker: Coming up today, we assess the outlook for emerging markets following a difficult few months.
Speaker: And we also look at the impact of high energy prices in Europe and whether recent sterling weakness has made the currency cheap.
Speaker: This podcast was recorded on Thursday, the 14th of October 2021.
Speaker: Our full disclosures and disclaimers can be found in the link attached to this podcast.
Speaker: Hello, I'm Mary Watkins.
Speaker: And I'm P.S.
Speaker: Butler.
Speaker: It was a tough third quarter for emerging market assets with fears over stagflation hurting investor sentiment.
Speaker: So are there any signs of improvement as we head into the remainder of the year?
Speaker: Murat Olgun is our global head of emerging markets research and he joins me now.
Speaker: Murat, welcome to the podcast.
Speaker: Thank you very much.
Speaker: So Murat, why did emerging markets perform so poorly in the third quarter?
Speaker: Yes, it's been a challenging year for EM, but the third quarter performance was particularly poor because emerging markets have to contend with so many moving parts in the investment backdrop, like COVID-19 headwinds that are continuing, the variants, downside risk to global growth, rising inflation and higher inflation volatility, a less supportive global liquidity backdrop.
Speaker: The looming tapering of asset purchase by the Fed, regulatory tightening in mainland China, a resurgent U.S. dollar, and very recently a spike in energy prices and a leg up in core bond yield.
Speaker: So it's the fear of stagflation, actually, that is creeping into the conversations.
Speaker: And this is the unpleasant mix of slow growth and higher inflation.
Speaker: So are investors right to be worried about stagflation?
Speaker: I think they are because emerging markets are now faced with a serious multiple negative supply side shocks and these negative supply side shocks are particularly taxing for emerging markets.
Speaker: The first one has been there for quite a long time.
Speaker: It's the continued global trade tensions and reversal of some globalization gains.
Speaker: And on top we have the supply chain disruptions caused by the pandemic.
Speaker: Recently, it's the spike in energy costs, and there is this impending tightening in global liquidity as the major center banks are edging towards normalization of ultra-loose monetary policy.
Speaker: How do you view the outlook for EM going forward?
Speaker: So, you know, our base case is that, you know, stagflation could be avoided, but clearly the risks are for slower growth and higher inflation for EM.
Speaker: So at minimum, the growth inflation makes it deteriorating for emerging markets.
Speaker: But does it mean that we should avoid emerging markets altogether?
Speaker: The answer is no.
Speaker: For one thing, we're still looking for a relatively decent growth in 2022, albeit with sticky inflation, parts of EM.
Speaker: But on top, the technical picture is very favorable.
Speaker: EM asset classes, particularly equities and some currencies, are cheap by historical standards.
Speaker: The positioning is quite light.
Speaker: And institutional investors have a large pile of cash.
Speaker: So to us, it's really the fundamentals that are obviously not favorable for EM, but the technical picture is quite supportive.
Speaker: Murat, thanks very much for that summary.
Speaker: Thanks for having me.
Speaker: Rising energy prices have been dominating the headlines over recent weeks, with record gas prices contributing to a rise in inflation here in Europe.
Speaker: Fabio Balboni, senior European economist, has been looking at what impact the crisis could have on the region's recovery.
Speaker: Fabio, what's the latest on the energy situation in Europe?
Speaker: Yes, well, energy prices have been surging recently, particularly wholesale gas and electricity prices.
Speaker: That is the result of almost a perfect storm of a contributing factor.
Speaker: We had the low gas stock at the end of last year's cold winter.
Speaker: We had a supply disruption.
Speaker: We had limited imports from Russia.
Speaker: and also surge in demand as a result of the unlocking of the economy.
Speaker: And again, other one-off factors such as, for example, the lack of wind, which has reduced the supply of alternative energy sources.
Speaker: So as a result of that, we've seen these huge increases in wholesale gas and electricity prices, which have more than doubled the
Speaker: since summer and some of these is starting to feed through to consumer prices and has pushed inflation to a more than 12 year high in September in the Eurozone at 3.4%.
Speaker: And on top of that, we're now also seeing rising oil prices, which are up more than 10% over the last few weeks and that could add the further pressure in terms of inflation.
Speaker: You mentioned inflation there.
Speaker: Can you give us some more detail on what the impact has been?
Speaker: Yes, absolutely.
Speaker: We have made some estimates in our latest note, and we calculated that if the latest increases in wholesale gas and electricity prices are fully passed through to the consumers, compounded by the latest increase in the oil price, that could push inflation down.
Speaker: to close to 5% year on year in the fourth quarter of the year.
Speaker: That's compared to our current forecast, which is 3.6%.
Speaker: So a huge upside risk.
Speaker: However, we do not think that this will be the case.
Speaker: So we see this as an extreme scenario.
Speaker: And that is because many countries have already announced interventions
Speaker: to prevent some of those price increases to be passed through to the consumers.
Speaker: We think that the peak will therefore be lower, but still significant pressure in terms of inflation, particularly in the near term.
Speaker: And of course, they could also turn into more persistent pressures if the increases in energy prices will prove more sustained.
Speaker: We could also see the risk that that starts to affect
Speaker: second round prices and in turn also possibly wages.
Speaker: So could all of this slow Europe's recovery?
Speaker: Yes, absolutely.
Speaker: We estimate in the note that price rises that we've seen so far in regulated energy prices combined with the recent oil price increase could reduce household incomes by about 0.6 percentage point.
Speaker: And as a result of that, they could take off 0.2 percentage point from GDP growth over the coming quarters.
Speaker: In an extreme scenario where the recent increases in wholesale gas and electricity prices are passed on fully to the consumers, of course, the impact will be bigger up to two percentage points in terms of income hit.
Speaker: and with 0.5% hit to growth.
Speaker: But as I said before, this is an extreme scenario.
Speaker: But having said that, there is the risk that we could see probably a slightly bigger impact than the 0.2% because first of all,
Speaker: happens at a time where eurozone growth is already slowing, but also because this shock will affect disproportionately poorer households, which have a higher propensity to consume, and therefore that could be more of a hit to consumption and therefore growth.
Speaker: So while we do not think it will be enough to derail the eurozone recovery, it could certainly take quite a lot of steam out of it.
Speaker: How do you think the ECB will react?
Speaker: The ECB so far has been very clear that they will look through this shock and therefore this will not change the course of monetary policy, at least in the near term.
Speaker: Certainly there's plenty of reason for that.
Speaker: This is an energy shock, one that the ECB cannot affect directly with its tool and it doesn't need to change the medium term
Speaker: inflation outlook, which based on the latest set of core forecasts, which we had in September from the ECB, still saw inflation well below the 2% targets in the medium term.
Speaker: However, markets are certainly questioned that, and we've seen the market pricing in terms of the first possible rate hike changing significantly recently, and the first rate increases are fully priced in by the end of next year.
Speaker: So clearly the market is questioned and the ECB facing some tough challenges ahead to make the case to continue to look through the shock and particularly as we head into the crucial ECB meeting in December, where the ECB is expected to deliver more stimulus.
Speaker: uncertainty is likely to remain elevated in the market.
Speaker: And clearly, while we remain of the view that more stimulus and in particularly an additional QE package will be delivered in December, clearly the shock has increased the medium-term risk for the monetary policy framework.
Speaker: And particularly if this shock proves to be more persistent, it could start have second round effect.
Speaker: and therefore also feeds through to higher wage growth.
Speaker: And if it does so in a more persistent manner, of course, it could make things more difficult for the ECB in the future.
Speaker: Fabio, thanks for your time.
Speaker: Thank you.
Speaker: We finish this week with a look at the prospects for sterling, where Dominic Bunning, head of European FX research, has been assessing whether the currency should be viewed as cheap.
Speaker: He joins us now.
Speaker: Dom, the consensus view is broadly positive on the outlook for sterling.
Speaker: What's your view?
Speaker: We continue to maintain a counter consensus bearish view on sterling.
Speaker: And if anything, the weakness that we've seen in the currency in the last few months brings it a little bit closer into line with our estimate of fair value for the currency.
Speaker: And actually that point is quite important because we think that the key difference in terms of our thinking versus the consensus around sterling is a different assessment of where long term fair value is.
Speaker: Ultimately, we don't think that the market has adjusted enough to take account of some of the big supply shocks that have happened to the UK economy in the last few years and that ultimately dragged down the level of fair value for the currency.
Speaker: So if you think sterling is close to fair value, where do we go from here?
Speaker: And the reality is that we see some competing forces which ultimately offset each other and don't really suggest that sterling should be significantly over or undervalued at this point.
Speaker: And therefore we see the currency really range trading if slightly drifting lower into the end of the year.
Speaker: And those competing forces come across a range of different dynamics.
Speaker: But for example, we've got relatively strong recent growth momentum being offset by what looks like quite a sharp slowdown in the months ahead.
Speaker: We've got a big repricing higher of rate expectations in the near term, but that's offset by a relatively low UK terminal interest rate.
Speaker: And on the external balance side of things, we've had this really strong improvement on the current account in the last few quarters, but that's already looking like it's reversing.
Speaker: So from our perspective, these competing forces ultimately suggest Serling should trade around its long term fair value in the months ahead.
Speaker: Dom, thanks very much.
Speaker: So that's it for today's programme.
Speaker: Thank you to our guests Murat Olgan, Fabio Balboni and Dominic Bunning.
Speaker: From all of us here, thanks for listening.
Speaker: Please join us next week for another edition of the Macro Viewpoint.
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.
