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Increased risk of “second-round” effects

We’ve been warning for some time that CPI inflation would rise further than most people expect, triggering a recession. The prospect of even bigger rises in utility prices on 1st October and in the first half of 2023 than we have pencilled in suggests that the risks to our forecast for CPI inflation to rise from June’s 40-year high of 9.4% to 12.5% in October are now skewed to the upside. That increases the risk of bigger, longer-lasting second-round inflation effects. Admittedly, there have been some encouraging signs that price pressures towards the start of the inflation pipeline have passed their peak. But it is worrying that domestic inflationary pressures, such as those in the services sector, are still rising, as they tend to last longer. As a result, we still think that the Bank of England will raise interest rates from 1.75% to 3.00% even when the economy is in recession.

10 August 2022

Emerging Markets Capital Flows Monitor

Capital outflows from EMs have eased over the past month, helping to stabilise local asset prices. But we think outflows will pick up again before long. That’s a threat to those EMs whose current account deficits have widened or are widening sharply, including Turkey, Chile and parts of Central Europe. Emerging Europe Drop-In (11th Aug): We’re expecting downturns in Central and Eastern Europe, but how bad could it get? Join this 20-minute briefing on our Q3 Outlook report, including the latest on Turkey, Russia and whether Hungary’s forint has further to fall. Register now.

10 August 2022

We think the worst is yet to come for most risky assets

Although we think that we have now passed this cycle’s peak in long-dated US Treasury yields, we still suspect that investors are underestimating just how far the Federal Reserve will raise interest rates, and how long it will be before inflationary pressures ease sufficiently for interest rate cuts to come onto the agenda. With that in mind, we think that the yields of most “safe” assets will end this year above their current levels. Meanwhile, given our relatively downbeat view of the global economy, we also expect most “risky” assets to see renewed declines, as risk premia climb and disappointing growth in corporate earnings undermines global equities. We think, though, that the outlook for most safe and risky assets is brighter in 2023 and 2024.

5 August 2022
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Dollar rallies as hope for a Fed pivot proves short-lived

The huge upside surprise in US payrolls data pushed the greenback higher against most major currencies today in an otherwise quiet week for FX markets. The continued strength of the labour market in the US adds to our conviction that the Fed remains some way off from taking its foot off the brakes, a message echoed by several Fed officials earlier in the week. By contrast, many other central banks face more difficult trade-offs: the latest labour market data from New Zealand and Canada showed falls in employment; the BoE and RBA both hiked by 50bp but revised their forecasts to reflect higher inflation and lower growth; and some emerging market central banks appear to be at or near the end of their tightening cycles. Next week’s US CPI data, which we expect will show continued strong core price pressures even if headline inflation slows, could put another nail in the coffin of the ‘pivot’ narrative. Even in the absence of further divergence in monetary policy, we expect slowing global activity and worsening risk sentiment to, underpin further strength in the greenback over the rest of the year.

5 August 2022

We think the dollar rally still has further to run

We think the dollar will appreciate further through at least the end of the year as the global economy continues to falter and “safe-haven” demand remains strong. Although we see limited scope for a further widening of expected interest rate differentials in favour of the greenback, we expect an environment in which the Fed and other major central banks continue to tighten monetary policy, even as economic growth slows, to support further dollar strength. We expect risky assets to remain under pressure for some time yet, and we believe that long-term yields have already peaked for this cycle. And previous peaks in the 10-year US Treasury yields have, more often than not, coincided with further dollar appreciation. We think a similar story will play out this time around as safe-haven demand makes the dollar, alongside the yen and the Swiss franc, the best performing currencies over the rest of this year and, probably, some way into 2023.

4 August 2022

CNB brings its tightening cycle to an end

The Czech National Bank became the first major EM central bank to end its tightening cycle after it left its policy rate on hold at 7.00% today. The communications were not as dovish as we had expected, but the new-look MPC is clearly less inclined to tackle inflation with further interest rates hikes than the last and we think it will also be one of the first central banks to cut rates next year. Emerging Europe Drop-In (11th Aug): We’re expecting downturns in Central and Eastern Europe, but how bad could it get? Join this 20-minute briefing on our Q3 Outlook report, including the latest on Turkey, Russia and whether Hungary’s forint has further to fall. Register now.

We think the latest asset price rallies will prove short-lived

We doubt the recent rallies in global bond and equity markets will be sustained over the remainder of the year. While we no longer think the 10-year US Treasury yield will exceed its June peak, we still expect it to rise as the Fed delivers a bit more tightening than investors now seem to anticipate. And we think government bond yields elsewhere will increase for similar reasons. We expect that, combined with a deteriorating economic backdrop, to place renewed pressure on “risky” assets; we forecast major benchmark equity indices – in both developed and emerging markets – to fall further this year, and expect corporate bond spreads to widen. But next year we think both “safe” and risky assets will fare a bit better, as central banks transition to easing mode and the economic backdrop starts to improve.

3 August 2022

Five questions and answers on frontier default risks

The spreads of sovereign dollar bonds over US Treasuries are in distressed territory in almost a third of EMs covered in the JP Morgan EMBI Index, with the majority of those being frontier markets. In this note, we answer five key questions on default risks in frontier markets. EM Drop-In (4th August, 10:00 ET/15:00 BST): Join our monthly online session on the big issues in emerging markets. In this 20-minute briefing, the team will be answering your questions about debt risks amid global tightening, the latest on the inflation outlook and much more. Register now. ​

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