Heightened volatility and uncertainty within the global market have led to a mixed performance across key regions over the month. Inflation levels in the US continue to taper downwards, a major driver for investor optimism, with peak rates now expected earlier in the year, although that peak may be higher for countries like the United Kingdom (UK), Europe, and South Africa (SA). While recessionary concerns have propped up, economic data out of the world’s largest economy remains robust with growth holding up relatively well. In addition, earnings season in the United States (US) continues to gather attention with the tally thus far being less bleak than expected. Looking across the pond, China dominated the headlines once again as economic data continues to surpass expectations. In terms of detractors, the surprise production cut announcement from the broader Organisation of the Oil Exporting Countries (OPEC+) led to a rally in oil prices which sparked some turmoil in the market. Higher oil prices are inflationary, and the major concern was how this will impact headline inflation globally and if it could result in a delay in core disinflation. Sticky inflation has seen central banks globally continue to hike rates, placing pressure on risk asset prices.
Looking more closely at the US (S&P 500: +4.2%), inflation slowed to 5% in March – the lowest since May 2021. This represents a meaningful slowdown from 6% in February and was below market forecasts of 5.2%. The continued upward pressure on rentals saw core consumer price index (CPI) tick up to 5.6% (February: 5.5%), however, this was in line with expectations. While the lower-than-expected headline print was well-received by some, stubbornly high core inflation will likely see the Federal Reserve (Fed) remain on its hawkish rate-hike path, with the swap market pricing in another 25 basis points (bps) hike in May. While the Fed has been adamant that it does not foresee cutting rates this year, traders are still betting a reversal could come sooner if the US economy runs out of steam. Banking fears were also reignited following disappointing numbers out of First Republic Bank which was not immune to the run-on deposits among regional banks when Silicon Valley Bank (SVB) collapsed last month. The bank is exploring an asset sale of long-dated mortgages and securities as part of a rescue plan – suggesting that other regional banks may still be in trouble as well.
China is boasting its strongest economic recovery (relative to estimates) in 17 years, with recent gross domestic product (GDP) data showing that the economy expanded ahead of expectations in quarter one of 2023 (+4.5% year-on-year, quarter four of 2022: +2.9% year-on-year) on the back of a better-than-anticipated recovery from harsh Covid-19 lockdown conditions. This reading was complemented by a slew of robust economic data releases including March numbers for retail sales (+10.6%, ahead of expectations), industrial production (+3.9%, in line), and unemployment (5.3%). The region’s modest growth target of ~5.0% for 2023 (2022: +3%) is still achievable as the economic recovery gains traction. This is also expected to be the main driver of global economic expansion in FY23 as persistent monetary tightening in other major economies continues to slow down economic growth. In terms of performance, the MSCI China Index (-2.7%), however, has lagged global peers as ongoing geopolitical tensions appear to be adversely affecting flows. European equities (STOXX Europe 600: +5.1%) performed well as the region recovered from the sell-off towards the end of March. This was underpinned by stronger-than-expected economic data thus far.
Economic Data Review
US inflation continues to taper downwards, however, core CPI remains sticky
Flash estimates showed that the S&P Global Composite Purchasing Managers’ Index (PMI) for the US increased to 53.5 in April 2023, from a final reading of 52.3 a month before. This was the quickest upturn in business activity since May 2022, driven by a broad-based rise in activity. Retail sales for March increased 2.9% year-on-year, lower than expectations (3.2%). In February, the trade deficit widened to $70.5 billion, compared to forecasts of $69 billion, as imports fell at a slower pace compared to exports. The unemployment rate in March edged down 3.5%, lower than market expectations of 3.6%. Annual inflation slowed to 5%, the lowest since May 2021, and below market forecasts. The Fed raised rates by 25bps in March 2023, matching the February increase. The FOMC members observed that inflation remained too high and that the labour market remained tight and, as a result, they anticipated that some additional policy firming may be appropriate to attain a sufficiently restrictive policy stance to tame inflation. Still, many participants noted that the likely effects of recent banking-sector developments on economic activity and inflation had led them to lower their assessments of the rate target range and that the collapse of two regional banks would likely tip the economy into recession later this year. The US economy grew by an annualized 1.1% in the first quarter of this year, slowing from a 2.6% expansion in the previous quarter and missing market expectations of 2% growth, a preliminary estimate showed. It was the weakest pace of expansion since the second quarter of 2022, as business investment growth slowed down, inventories declined, and rising interest rates continued to hurt the housing market.
European Central Bank members maintain a hawkish stance to combat high inflation levels
On a preliminary basis, the S&P Global Eurozone Composite PMI increased to 54.1 in March, compared to 52 a month before. This was above expectations of 51.9. Retail sales in February were down 3% year-on-year, compared to forecasts of a 3.5% decline. A trade surplus of €4.6 billion was recorded in February, compared to forecasts of a $11.9 billion deficit, as exports rose 7.6% year-on-year and imports climbed a softer 1.1% year-on-year. The unemployment rate stood at a record low of 6.6%, slightly below market estimates of 6.7%. Consumer price inflation for March came in at 6.9%, slowing from 8.5% a month before. Most European Central Bank (ECB) policymakers agreed to raise key interest rates by 50bps last month, as expected, though some members would have preferred not to increase rates until the financial market tensions had subsided. The ECB is set to deliver a 25bps rate increase in May and another two are expected by mid-year after raising borrowing costs at the fastest pace on record to combat inflation.
Inflation unexpectedly edged higher, but the market anticipates a sharp fall towards the latter part of the year
Initial reports showed that the S&P Global/CIPS UK Composite PMI rose to 53.9 in April, beating market expectations of 52.5. Retail sales volumes decreased 3.1% y/y in March, compared to forecasts of a 3.1% drop. In February, the trade deficit widened to £4.81 billion as exports dropped 2.7% and imports declined at a slower 0.8%. Slightly ahead of market expectations, the unemployment rate increased to 3.8%. Annual inflation in the UK unexpectedly edged higher to 10.1% in March. The Bank of England raised its key bank rate by 25bps during the March 2023 meeting, in line with expectations. Inflation is still likely to fall sharply over the rest of the year and to a lower rate than anticipated in February, but policymakers warned that if there were to be evidence of more persistent pressures, then further tightening would be required. On the recent banking crisis, the central bank noted that the UK banking system maintains robust capital and strong liquidity positions and remains resilient. Policymakers will also continue to closely monitor any effects on the credit conditions faced by households and businesses, and hence the impact on the macroeconomic and inflation outlook.
Data out of China remains robust and continues to surprise to the upside
China’s composite PMI rose to 54.5 in March, from 54.2 a month before. It was the third straight period of growth in private sector activity and the strongest pace since last June amid the removal of strict pandemic measures. Retail sales expanded 10.6% year-on-year in March, exceeding market consensus. Better than market forecasts, the country’s trade surplus widened to $88.19 billion in March, compared to $44.35 billion over the same period a year ago, as exports jumped unexpectedly by 14.8% and imports dropped less-than-anticipated by 1.4%. The surveyed urban unemployment declined to 5.3% in March. China's annual inflation rate unexpectedly came in at 0.7% in March, compared with February's print and market consensus of 1%. This was the lowest figure since September 2021, as the cost of both food and non-food eased further on the back of an uneven economic recovery after the removal of the zero-Covid policy.
Inflation in Japan continues to fall; however, policymakers remain cautious
Early estimates showed that the Jibun Bank Composite PMI reading in April edged lower to 52.5. This is the fourth straight month of expansion in private sector output, with a resurgent service economy helping to offset a weak manufacturing sector. Retail sales for February increased 6.6% year-on-year, exceeding the market consensus of a 5.8% gain. Japan’s trade deficit widened to ¥754.7 billion in March, compared to ¥464.9 billion in the same period a year ago. This was better than the estimated gap of ¥1.3 trillion. The unemployment rate was unexpectedly lower at 2.6%, compared to forecasts of 2.4%. Annual inflation fell to 3.2% in March, in line with consensus. This was the lowest print since last September, as the cost of transport rose the least in six months while prices of fuel, light, and water charges dropped much faster. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations. Policymakers indicated their concerns over the economy by lowering their views on exports and production while leaving the overall economic assessment unchanged. The BoJ reiterated that it would take extra easing measures if needed while expecting short-and long-term policy interest rates to stay at their present or lower levels.
Outlook
Global
- Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as fiscal and monetary policy, particularly in the US, will likely be on a restrictive path. In particular, the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns.
- Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary-related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. This, combined with lower savings rates, subsiding government transfer payments, and depressed real disposable income will likely erode demand.
- At the moment, households will likely continue utilising various credit instruments, particularly credit card debt, which is currently at all-time highs, to prop up short-term expenditure prospects.
- Nevertheless, if liquidity remains plentiful due to the emergence of various Federal Reserve facilities that have been utilised by the banking sector, this may prevent price discovery from emerging in the short term.
- While the Fed intends to tighten financial conditions heading into 2023, these facilities have largely reversed their intent and may complicate the inflation trajectory at a later stage.
- Nevertheless, we believe that the loosening of financial conditions in recent months will likely embolden the Fed to be on a restrictive path as we progress into the year as tightening financial conditions will be needed to bring inflation down to more sustainable levels. Similar sentiments will likely be shared by the Bank of England and almost certainly the Eurozone Central Bank, which is currently grappling with all-time-high core inflation.
- Chinese economic and mobility data continues to improve, and monetary policy remains on an accommodative path. It is encouraging to see China gradually re-open and Covid-19 cases well off their peak. While we remain cautious of further haphazard policy pronouncements, we are constructive on the outlook for China.
- Nevertheless, tensions between China and Taiwan have recently escalated and have likely resulted in investor jitters toward the region despite an improving economic backdrop. While it is certainly not our base case that an invasion takes place, it remains a tail risk.
- One peak hawkishness of the Fed has been sufficiently priced in by market participants, and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the bond curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. At this stage, we believe that the rate-cutting cycle priced in by the futures curve is premature.