Back To The Drawing Board

By Teeuwe Mevissen, Senior Macro Strategist at Rabobank

As we are about to approach the end of this trading week it sometimes leads us to reflect on all that has happened; especially when a lot has happened, like this week.

Clearly, we started the week with news about a coup attempt in Russia. Where would we have been, had this attempt been successful? Was it even a coup attempt or was it really about Gerasimov and Shoigu, as Prigozhin claims it was? And how would a successful attempt have affected the war in Ukraine? All interesting counterfactuals for historians, but for now we can only conclude that Putin’s position might not be as solid (anymore) as many thought it was. Therefore there is still more than enough reasons for Putin to worry and to maybe get back to the drawing board regarding the course that he chose since the 24th of February 2022.

We had to wait until Thursday for real macro-economic news but the monetary news from this week was exciting enough. It seemingly took markets quite some time to properly assess the monetary impact of what has been said during Europe’s Central Bank Forum in Sintra, Portugal. Initially we saw a sharp rise in interest rates along the whole curve, this was quickly followed by declining rates at the end of Wednesday’s trading session. But it was yesterday at 14:00CET after it turned out that inflation in Germany was rising again that rates started their ascend. Interestingly enough it were the longer maturities that saw the sharpest rise in yields. Clearly markets were busy positioning themselves for the inflation data from both the Eurozone and the US that will come out today.

But there was more than higher-than-expected inflation in Germany that resulted in significantly higher rates yesterday. Data from the US, which also came out yesterday, showed that annualized quarterly growth over the first quarter of this year turned out to be 2% QoQ instead of the 1.4% QoQ reported earlier. And, maybe even more important, personal consumption came out at 4.2% instead of the earlier estimate of 3.8%. In other words, demand was much stronger than anticipated and this means more work for the Fed since apparently the restrictive area that we are supposed to be in is not so restrictive after all. While European yields rose between 6 and 8 basis points, the 2-year yield on US bonds jumped no less than 16 basis points.

For those who were hoping for lower rates, yesterday’s jobless claims must have been yet another disappointment. The benefit applications fell the most since October last year and that week (ending on the 24th of June) even included the Juneteenth holiday. While we have to wait until Friday next week to get a better picture of the US labour market it still doesn’t seem that the labour market is cooling off in earnest. For now, expectations that the Fed could hike more than previously anticipated resulted in a strong dollar, pushing EUR/USD lower and below a level of 1,09.

Meanwhile China is dealing with its own challenges that are wildly different from the challenges that the West is facing. While both China and the West have to deal with a slump in the manufacturing sector, China does not have an inflation battle to fight. At least not yet. China’s economy is struggling because local governments, the real estate sector and households have too much debt. China seeks to transform its economy from an export based model to a model of dual circulation that also relies on domestic consumption.

However, given the circumstances outlined above, the latter will prove to be everything but easy. Currently, consumers are mainly busy with deleveraging. This is reflected in higher savings ratios and early mortgage repayments that hit a 5 year high according to Fitch Bohua. While it is a necessary step for households to deleverage, it does put a lot of pressure on the expected interest rate returns of China’s banking sector.  Moreover, today’s PMI’s coming from China shows a continuous cooling of the manufacturing sector and a lower than expected value for the services sector (53.2 vs 53.5 expected) in June which also came out lower than the survey for the previous month.