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: On this week's programme, we consider the outlook for monetary policy on both sides of the Atlantic as we assess the prospects for rate rises by the European Central Bank and the Federal Reserve.
Speaker: And we consider whether there could be further disruption to the gas market following Russia's decision to cut supply to parts of Eastern Europe.
Speaker: This podcast was recorded on Thursday, the 5th of May, 2022.
Speaker: Our full disclosures and disclaimers can be found in the link attached to this podcast.
Speaker: Hello, I'm Aline van Dyn.
Speaker: And I'm Piers Butler.
Speaker: We begin this week in Europe, where record high inflation is increasing the pressure on the ECB to begin policy tightening, despite the mounting risks to growth.
Speaker: We're going to get the views of Simon Wells, Chief European Economist, and Dominic Bunning, Head of European FX Research, will also tell us what more aggressive action could mean for an already under-pressure euro.
Speaker: So Simon, if we can start with you, can you just update us on what your outlook for the ECB is at the moment?
Speaker: Yes, of course.
Speaker: I mean, the ECB is obviously in a different place to some of the other central banks.
Speaker: It is still winding down its quantitative easing program, is yet to raise interest rates.
Speaker: And if you look at its inflation forecasts, it was expecting inflation to come down fairly quickly.
Speaker: That being said, the market has been long pricing in much more aggressive ECB action.
Speaker: with it starting to raise rates from the summer.
Speaker: And policymakers from the ECB really haven't pushed back on this much recently.
Speaker: And if you look at the latest data, business activity is holding up in the eurozone and inflation continues to surprise to the upside.
Speaker: Therefore, when I look at our own outlook for the ECB, probably it's maybe going to be a bit closer to the market now with slightly more aggressive rate rises this year than we might have been seeing previously.
Speaker: So, Dom, how do you square the circle of more rate heights and yet a negative outlook for the euro?
Speaker: Thanks, Biz.
Speaker: Yeah, I mean, it's a good question, because normally you do think higher rates mean stronger currency, right?
Speaker: But I think the difficulty that Europe faces is that it's got this really challenging mix of growth expectations being pulled lower while inflation expectations or inflation itself is being pushed higher.
Speaker: And that makes the ECP's task really, really tricky.
Speaker: And I think the FX market is almost looking at saying, well, look, if you tighten a bit too much and get it wrong on that direction, it's going to be really bad for growth.
Speaker: That's bad for the euro.
Speaker: If you don't tighten enough, then inflation is going to run away.
Speaker: And that's bad for the euro.
Speaker: So it's such a narrow landing path for the ECB to kind of get it right on that.
Speaker: I think the FX market's almost saying this is this is going to be very tricky.
Speaker: And therefore, the pressure almost is being felt through the currency.
Speaker: And we sort of agree with that view that it's just going to be very, very tricky over the next six months or so for the ECB to really calibrate things perfectly, given the pressures they're facing.
Speaker: And that's ultimately going to be, you know, a negative force for the euro.
Speaker: So it's fair to say that the ECB is in a tough spot.
Speaker: What about the Bank of England?
Speaker: Are they in a similarly difficult situation?
Speaker: Well, the Bank of England met on Thursday and hyped rates by 25 basis points, as most of the market was expecting.
Speaker: The vote itself was a little bit hawkish in that there were three votes for a 50 basis point rise.
Speaker: On the other hand, if you look at the MPC's forecast for the UK economy, it was pretty dovish.
Speaker: You had GDP growth actually falling through 2023, and you had an inflation forecast at the end of the forecast
Speaker: that was one of the biggest forecast undershoots on record.
Speaker: So I think that really brings out this dilemma that you were talking about, Piers.
Speaker: On the one hand, you've got medium-term dovishness.
Speaker: On the other hand, in the near-term, inflation just keeps on rising.
Speaker: So yes, it is the same position for the Bank of England.
Speaker: But I think on balance, after their May meeting, the market saw it as net dovish, very much focusing on these macro forecasts.
Speaker: And Dom, you've had a bearish stance on Sterling.
Speaker: Do you maintain that?
Speaker: Yep, absolutely.
Speaker: And if anything, we've, you know, we've extended that view to some extent, you know, we're looking for Sterling to keep falling from where we are now.
Speaker: And, you know, Simon's points around the Bank of England, I think are all really valid there.
Speaker: And the market certainly is focusing more on those medium term projections.
Speaker: And effectively, the fact the Bank of England is telling the market, you know, I would say quite clearly that it's
Speaker: going to find it difficult to hike rates to the degree that the market has priced in.
Speaker: And that therefore will make it very difficult for sterling to capitalize, even if the bank does deliver a few more rate hikes.
Speaker: So I think sterling faces a very similar challenge to the euro.
Speaker: And also on top of that, you've got potentially some negative forces coming through the current account, which seems to be broadly widening out again.
Speaker: And a third point, which also links back to the euro actually, is about valuations.
Speaker: You know, people might think that sterling looks cheap and actually similarly for euro, that it looks cheap.
Speaker: And nominally, yes, the levels of those currencies look quite low.
Speaker: But when you think about it more from an economics and valuation, real effective exchange rate type perspective, neither currency actually looks that cheap from our perspective.
Speaker: And therefore, we think that both sterling and euro for those kind of similar reasons can both see further downward pressure.
Speaker: Simon and Dominic, many thanks.
Speaker: Thank you.
Speaker: Thanks.
Speaker: So there's potential for policy tightening sooner rather than later in Europe.
Speaker: But here in the US, the Federal Reserve cycle is well underway, with the bank this week raising interest rates by another 50 basis points, the first increase of that size for over two decades.
Speaker: Ryan Wang, US economist, joins us from New York.
Speaker: So Ryan, any surprises from the Fed this week?
Speaker: Hi, Aline.
Speaker: Well, the broad decisions were not surprising.
Speaker: The FOMC voted unanimously to raise the federal funds target range by 50 basis points.
Speaker: There was the formal announcement of quantitative tightening, largely along the lines that had been already flagged to financial markets.
Speaker: There were some nuances when it came to Fed Chair Jerome Powell's press conference, however, specifically when it came to the question about whether even larger rate increases of
Speaker: for example, 75 basis points at a single meeting were being contemplated, Chair Powell said that no, they weren't on the table and weren't being actively considered.
Speaker: But he did clarify that additional increases of 50 basis points would be on the table for the next two policy meetings if economic conditions evolve the way that policymakers expect.
Speaker: So sounds like 50 basis points will be around for a little bit longer.
Speaker: Ryan, what are the key things to look out for in terms of how long this lasts?
Speaker: Right.
Speaker: Well, the FOMC's intention seems to be to move policy rates up towards a neutral level
Speaker: in a fairly rapid manner.
Speaker: And Chair Powell again said that that would be done expeditiously.
Speaker: The FOMC estimates that neutral level to be around 2.4%.
Speaker: And the question about whether policy rates will need to move to a restrictive level is a question for the future.
Speaker: It will depend on how the economic data evolve.
Speaker: So it'll be important to watch the inflation data going forward.
Speaker: And it'll also be important to track the economy's momentum.
Speaker: Fed Chair Powell in his press conference talked about how job gains could moderate a little bit from the very rapid pace we've seen over recent months.
Speaker: And he also indicated that the Fed would be paying close attention to financial conditions and the impact of tighter monetary policy.
Speaker: There's a few channels by which policy can affect those conditions, including asset valuations in the stock market and the housing market.
Speaker: And also higher interest rates impact spending.
Speaker: So these are all of the types of things that will inform the decision about how far and how fast that eventually ends up moving on its policy rate.
Speaker: And Ryan, there was some mention of the slowdown and the lockdowns in China, right?
Speaker: Well, that's right.
Speaker: The lockdowns in China, in some sense, add to the supply chain difficulties that are affecting global conditions.
Speaker: And of course, this has been a source of inflationary pressure in the US.
Speaker: So once again, we have a set of developments which is creating downside risks to growth, but potentially upside risks to inflation.
Speaker: Ryan, thanks for the update.
Speaker: And we'll speak to you after the next Fed meeting.
Speaker: Thanks a lot, Aline.
Speaker: Now, we've heard a lot today about inflation.
Speaker: And of course, one of the key upward drivers on that has been higher energy prices.
Speaker: And there have been further developments in the gas market, where last week Russia terminated gas supplies to Poland and Bulgaria, raising the risk of further disruption across Europe.
Speaker: Kim Fustier, oil and gas analyst, joins us to assess the outlook.
Speaker: Kim, welcome back to the podcast.
Speaker: In fact, the last time I interviewed you, I think I said that it was likely that you'd be coming back to talk about the situation on gas prices.
Speaker: And here we are again.
Speaker: So perhaps just to kick us off, give us an update as to what the latest developments have been.
Speaker: Sure.
Speaker: So Russia stopped gas deliveries to Poland and Bulgaria on 27th of April on the grounds that these countries did not comply with Russia's decree to be paid in rubles.
Speaker: So that's yet another game changer that shows that Russia is prepared to follow through on its warning that it will cut off supply of gas unless it's paid in rubles.
Speaker: So at this point, there are no good options for European buyers.
Speaker: Either they face the risk of cutoffs, which we cannot rule out, or risk being in violation of sanctions in the eyes of the EU.
Speaker: The next round of gas payments will fall in the second half of May.
Speaker: And so the next few weeks will certainly be interesting to watch.
Speaker: At this point, large scale disruptions to key buyers such as Germany or Italy are not in our base case.
Speaker: But smaller countries, which are somewhat less dependent on Russian gas, could decide to go the way of Poland, which might then lead to their gas supply being cut off as well.
Speaker: So in your research report, you talk about expecting a cut in Russian gas flow.
Speaker: But nevertheless, as we talked about before, diversification away from that flow is actually very hard to do.
Speaker: That's right.
Speaker: We've already seen a 25% year-on-year decline in Russian gas flows to Europe, and that's before gas supplies were cut off to Poland and Bulgaria.
Speaker: And so much of that gap right now is being filled by spot LNG imports, which are very expensive because there is no spare capacity in the global LNG system.
Speaker: In the longer term, we now assume a 40% decline in Russian gas flows by 2028, and that more or less tracks the
Speaker: the decline in Europe's fossil gas demand, that would not be quite enough to meet the EU's goal to wean itself entirely from Russian gas by then.
Speaker: And so that still leaves a big chunk of missing supply.
Speaker: And despite Europe's efforts to reach out to other gas producers, such as North Africa or Norway or Azerbaijan, I think the incremental volumes we'll get from these countries are just a fraction of Russian supply.
Speaker: And so that leaves Europe still really dependent and vulnerable
Speaker: and having to outbid, in particular Asia, for those spot LNG cargoes.
Speaker: So not surprisingly, in terms of supply and demand dynamics, the high gas price has had an impact on demand and the demand outlook.
Speaker: Nevertheless, prices are remaining remarkably tight.
Speaker: Can you talk about that?
Speaker: We have seen a 7% year-on-year decline in European gas consumption in the first quarter.
Speaker: We've also seen Asian LNG imports come down by more than 10%.
Speaker: And that's really because of high prices.
Speaker: So you're right.
Speaker: There is some degree of demand destruction here.
Speaker: In China, on top of that, you've got the negative impact of the COVID-19 lockdowns.
Speaker: So the way we read this is that this is in fact good evidence that the market is incredibly tight and that prices remaining incredibly high despite demand destruction because there's simply just not enough supply.
Speaker: So for us, if anything, this points to potential price upside if you've got further gas supply disruptions for whatever reason, or if demand rebounds, for example, if the Chinese lockdowns are lifted.
Speaker: Finally, can you update us on what you've done to your gas price forecasts?
Speaker: So we've marked the market gas prices to the forward curve.
Speaker: And our thesis of higher for longer gas prices is still very much intact.
Speaker: What's particularly worrying is that we don't see much improvement at all in the next couple of years compared to this year in terms of supply and demand.
Speaker: There's very little new gas capacity coming on stream, whether pipeline or LNG.
Speaker: It's quite possible that the market could remain as tight as it is today in the next couple of years and that things don't really improve before 25, 26.
Speaker: Kim, thank you very much.
Speaker: Thank you.
Speaker: So that's all from us today.
Speaker: Thank you to our guests, Simon Wells, Dominic Bunning, Ryan Wang and Kim Fustier.
Speaker: We hope you found today's program useful.
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.
