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The Macro Viewpoint - ECB hawks take control, EM Sentiment Survey, USD outlook
28 Plays3 years ago
In this edition we assess how the ECB is set to end years of loose monetary policy, find out why investors have become even more bearish on emerging market assets and consider how the dollar would likely behave were the US economy to slow.
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Transcript
Introduction to the Podcast
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This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
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Join us as we hear from industry leaders and HSBC experts on the latest insights and opportunities for your business.
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Thank you for listening.
European Monetary Policy Outlook
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You're listening to the HSBC Global Research Macro Viewpoint, where we speak to the economists and strategists behind some of our key reports.
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On this week's programme, we assess the outlook for European monetary policy, where the ECB has opened the door for its first rate rise in a decade.
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We find out why investors have become even more bearish on emerging markets.
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And we consider how the dollar would likely behave were the US economy to slow.
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This podcast was recorded on Thursday, the 9th of June, 2022.
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Our full disclosures and disclaimers can be found in the link attached to this podcast.
ECB's Rate Hike Plans
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Hello, I'm Piaz Butler.
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And I'm Aline Van Dyne.
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We begin this week in Europe, where at the ECB meeting, hawks have taken control.
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Let's get the details from Simon Wells, our chief European economist.
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So Simon, tell us about the hawkish shift at the ECB.
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Well, it was a little bit hawkish.
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The ECB was unusually specific in telling us what it intends to do.
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So as was widely expected, it didn't raise interest rates at the June meeting, but it did basically tell us it was going to raise rates by 25 basis points at the next policy meeting.
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on the 21st of July.
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And not only did it do that, but it then went on to say intended to raise rates again in September.
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And unless there was an improvement in the inflation outlook, that that rate hike would be bigger.
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So therefore signaling a 50 basis point rate hike.
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And then thereafter, there would be a gradual path up in policy rates.
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So yes, quite explicitly hawkish.
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So, Simon, what does this mean for the rate cycle?
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A bit of a shift, a bit of a U-turn even?
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Certainly far from pushing back on market expectations of ECB policy rates.
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Christine Lagarde and the ECB pretty much endorsed them in some ways, at least in the near term.
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So it does look like we are going to have more aggressive tightening in the eurozone.
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But in large part, that reflects the fact that the ECB significantly raised its inflation forecast and also cut its growth forecast as well.
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So the if you like, the growth inflation tradeoff in the eurozone has deteriorated once again.
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Simon, the ECB has been wrong, many forecasters have been wrong, but the market has been right in terms of the need for more interest rate hikes.
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Any reason to think that forecasters may be right now?
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I still think there are some good reasons.
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Yes, you're right, the market is expecting quite aggressive monetary tightening from here on in and with 8.1% inflation, that's understandable.
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But by the time we get sort of past Q1 of next year, we have to remember that the ECB is worried about fragmentation risk.
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It has to manage monetary policy for 19 economies with different fiscal policies and different debt levels.
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The industrial recovery is stuttering a bit, particularly in Germany.
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And of course, there's still a big real terms income squeeze for households and consumers.
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So the demand outlook is fragile.
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And when you put it all together with some of the risks that are still out there, I think there is still every reason to think that not all of market expectations will be satisfied.
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Simon, in terms of that growth inflation trade-off, just remind us what we're expecting there, because it is not looking that good, is it?
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No, it's not.
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And the reason for that is because what we're really seeing are adverse shocks to global aggregate supply.
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It is deteriorating that tradeoff.
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We haven't made any changes to our growth forecasts, but we have raised our inflation forecasts again.
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So this year, we now think inflation will average 7.3% in the Eurozone.
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Previously, that was just 6.6%.
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So energy prices have re-accelerated, but it's not just that.
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Inflation's broadening out.
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Food, of course, is seeing a lot of inflation.
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So, too, is the service sector.
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And given some of the supply disruption still ongoing, I'm afraid there's a bit more cost inflation to come.
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Simon, thanks so much for the update.
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Thank you.
Emerging Markets Sentiment Survey
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This week, we released the eighth edition of the HSBC Emerging Markets Sentiment Survey.
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The survey canvases the opinions of 125 investors from 120 institutions with over half a trillion dollars of assets under management in emerging markets.
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Murat Olgun is the Global Head of Emerging Markets Research, and he joins us now.
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Murat, welcome to the podcast.
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Thank you very much.
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So investors were quite cautious on EM assets in the March survey.
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How have their attitudes changed since then?
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Yes, they were cautious and they got even more cautious or perhaps a better way of saying it is the sentiment is pretty depressed because the share of investors who are now bullish on emerging market prospects over the next three months has sunk to its lowest level.
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Only 15% is the lowest since the inception of the survey two years ago.
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and also the net of bullish versus bearish sentiment stands at its lowest.
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And consistent with that gloomy mood, cash holdings just keep going higher.
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Those with more than 10% cash in their portfolio as a percent of assets under management
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it shot up to 33%, and it was already pretty high, 25% in the previous survey.
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So what are investors most concerned about?
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Well, this survey was conducted between 21st of April and 1st of June.
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So the fieldwork coincided with heightened volatility in financial markets, especially in the equity markets.
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And that's on the back of a deteriorating global economic outlook with weaker growth and sticky high inflation,
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leading to increasingly hawkish narrative by global center banks.
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And obviously, all these rules were further compounded by the ongoing Russia-Ukraine war and its spillover to supply chains, causing disruption, particularly for the energy and agriculture commodity products.
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And actually, in this survey, we also asked investors about recession probabilities.
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And around two-thirds expect a recession in Europe over the next two years, while for the U.S., this is 56%.
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So lots of worries about global economic activity, the outlook for China growth, high inflation, hawkish global center banks, and obviously the impact of the war across the supply chains.
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And how is all this reflected in the level of risk that EM investors are willing to take?
Investor Risk Appetite and Regional Focus
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So we ask investors in every survey, every quarter, the level of risk they're willing to take at the current juncture in emerging markets.
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We give them a scale from zero to 10, where zero is no risk and 10 is the highest risk, NEM.
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And in this survey, the weighted average score dropped further to 5.17%.
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It was already low in the previous survey, 5.75.
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And 5.17 is the lowest since the inception of the survey again.
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But then interestingly, there is a group of investors, maybe some outliers, about 6%, who expressed very strong risk appetite, 9 to 10, something we haven't seen over the past surveys, which I think is quite notable.
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Maybe this group of investors might be thinking the peak bearishness might have passed.
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Finally, what are the implications for strategy?
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Yes.
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So investors still want to position in Latin America and Middle East.
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This is where they are most overweight in terms of regional geographical choices.
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But when it comes to Latin America, the forward looking expectations are also quite positive because the net sentiment is positive across all asset classes.
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One might argue, you know, Latim and Middle East obviously benefits a lot from elevated commodity prices.
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But in the case of Latin America, it's probably also potentially expectations of peak rates because there is strong interest in bond markets for this region, both local and hard currency.
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And on the flip side, Central Eastern Europe saw another big leg down in net sentiment.
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When it comes to EMFX, investors generally expect depreciation.
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59% expect EM currencies to weaken over the next three months.
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But Brazilian Real and Chinese Renmin stand out as the favorite currencies.
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In EM fixed income, the preference is still for the hard currency debt.
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And finally, on EM equities, it seems like investors have trimmed their bullishness when it comes to emerging market equities.
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Marat, thanks very much for the update.
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Thank you very much for having me.
Dollar Behavior During U.S. Economic Slowdown
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We finished the podcast in the currency markets, where the dollar has retreated from the highs seen in May.
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And amid rising concerns over the trajectory of the U.S. economy, Dara Ma, head of FX strategy in the U.S., has been investigating how the dollar could behave during a slowdown.
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He joins us now from New York.
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So, Dara, do the historical data provide any clues about how the dollar reacts when the U.S. economy slows?
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Yes, history can be a guide.
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We've looked at 50 years of data, the relationship between leading indicators in the US of activity and the US dollar.
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And I guess the key takeaway that we would draw is that it depends on how much the US economy slows.
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If the US economy slows just a little bit, then you typically have seen some dollar weakness.
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So maybe that's consistent with the price action we've seen of late in markets.
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But if you extend that into kind of recession scenarios or greater concerns about economic activity in the US, then typically what you in fact see is a stronger US dollar, presumably reflecting its safe haven bid.
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So really, it's history, at least would suggest that it depends on how much you expect the US economy to slow.
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The Fed is tining policy.
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What impact could that have?
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Well, the Fed's attitude is critical to the dollar.
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As you say, they are tightening policy.
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They've begun interest rates.
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We're expecting more to come.
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The spin to the dollar is that the activity indicators, if they're soft enough, will they perhaps encourage the Fed to believe that they've done enough or they don't need to raise rates quite as much or guide to raising rates quite as much?
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That's the typical, if you like, transfer from activity to rates to FX.
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But in this cycle, the Fed is trying to slow economic activity.
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It wants to see activity slow, demand slow, to bring it more into line with supply.
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And that's, of course, what therefore brings inflation under control.
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So it's not clear that just because we're seeing U.S. economic slowing, that needs to translate into kind of a more dovish guidance on rates or not indicating rates have to go up quite so far.
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and therefore dollar weakness.
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That kind of mechanism I don't think necessarily holds in this tightening
Global Slowdown's Impact on the Dollar
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cycle.
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Of course, the US isn't the only country facing economic challenges.
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How would the dollar respond to slowing global growth?
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No, you're right.
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It's in fact, you know, we talk about U.S. exceptionalism.
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And in this context, the U.S. is not exceptional.
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Many economies are facing this growth inflation tradeoff.
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Most of them are raising rates to try and bring inflation under control, particularly in the G10 space.
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So really what we're talking about is not a U.S. economic slowdown.
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We're talking about efforts globally to rein in demand to bring inflation under control.
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So it's a global slowdown.
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Now, again, using the same kind of approach as we used just for the US, if we look at the OECD as a whole and their leading indicators, what we see here is if there's slowdown, that typically, whether that slowdown is modest or pronounced, that the dollar has strengthened.
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So, yeah, it's an interesting dynamic.
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And I think maybe what people have lost sight of over the last few weeks is that this isn't just US phenomenon.
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It is potentially and most likely a global phenomenon.
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putting this all together, how do you view the outlook for the dollar?
00:12:44
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Look, we've been in the bullish camp for the dollar.
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We still are.
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We look for some modest strength ahead, notably against the euro, notably against sterling.
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We're perhaps a little more agnostic on
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how the dollar might perform against some of the currencies like the Australian dollar, New Zealand dollar, or others, perhaps not as much upside for the US dollar there.
00:13:03
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But for something like the Euro, who are behind the Fed in terms of pace of tightening and other aspects of the policy mix, we see downside on UK for various economic fragilities that the UK economy faces.
00:13:18
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And we don't think a US slowdown
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undoes that dollar bullishness.
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And it's a very narrow path that dollar bears have.
00:13:26
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To be bearish on the dollar, in our opinion, you need to anticipate the Fed will manage to slow the economy, but not too much.
00:13:33
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So we don't get a recession, but by just enough to bring inflation under control.
00:13:37
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That strikes us as quite a narrow path for the currency market to anticipate.
00:13:42
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So I think the preference still will be for the dollar to strengthen.
00:13:46
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Dara, thanks very much for explaining that to us.
00:13:49
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Thank you.
Podcast Conclusion and Resources
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So that's all from us today.
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Thank you to our guests, Simon Wells, Murat Organ, and Dharamar.
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And thanks to all of you for listening.
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We'll be back again next week.
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Thank you for listening today.
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This has been HSBC Global Viewpoint, Banking and Markets.
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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.