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• Global

  Recent survey evidence from the PMIs has continued to point to a slowdown in global economic activity, the Composite reaching a 7-month low of 50.6. However, there are some interesting differences, with emerging markets (EM) outperforming developed market (DM) peers. This is visible on a sector basis too, with a continuing contraction seen in DM manufacturing, where for example the slowdown in China has hit Germany in particular. Meanwhile government policy in places such as India has been supportive. At the same time services growth has witnessed a sharp downturn in DM as interest rate rises have begun to hit demand.

  Chart 1: PMIs point to slowing global activity, but EMs outperform

  

  Source: Macrobond, Investec Economics

  Perhaps an indication of this is the divergence between Japan and other DMs. Japan has maintained an ultraloose stance of policy and continues to see healthy services activity (54.3), at a time when it has slowed to a crawl at 50.2 in others. However, as above not all EMs are seeing healthy growth, with China continuing to struggle. The latest figures for August may have offered some encouragement with annual growth in industrial production and retail sales rising, but this was flattered somewhat by favourable base effects. Our forecasts are unchanged with China expected to grow 4.8% this year putting it on track to undershoot the 5% GDP growth target

  Chart 2: Chinese indicators see some improvement in August

  

  Source: Macrobond, Investec Economics

  Consequently, a question is why the policy response has been timid so far. The PBoC for example has only cut the RRR and LRP* by 50bps and 20bps respectively this year. A factor here may be worries of fuelling further Yuan weakness against USD. The government has also avoided mass stimulus; instead, measures to support the property market for example have been delegated to individual cities. Debt concerns likely play a part here. In the past stimulus has been injected via large-scale investment, often funded by LGFVs. This has often been in infrastructure and not been highly profitable, meaning debt servicing has been met through land sales. However, as the property market has weakened and revenues dried up, pressure has built on what the IMF estimates is $9trn** worth of LGFV debt, which in July had seen 48^# missed payments.  

  Chart 3: Local government finance vehicle (LGFV) debt has almost doubled in five years

  

  RRR- Required Reserve Ratio, LPR- Loan Prime Rate, ** Converted at USD:CNY 7.0, # Bloomberg report 7-Aug: 48 LGFVs overdue on Commercial Paper payments in July, an increase of 19 versus June.
  Source: Macrobond, Investec Economics, IMF 2022 China Article IV

  We don’t necessarily see this turning into a crisis, but it may mean stimulus is less forthcoming and Chinese growth underperforms. But we will be looking for policy guidance during the Third Plenum in October. This China outlook has implications for global growth, for example its annual contribution to world GDP is 0.9%pt this year versus 1.1%pts in the five years prior to Covid. It also has ripple effects elsewhere and is one reason why we have downgraded Germany and consequently the EU20 for ’23 and ’24. However our forecasts for global growth are unchanged at 2.7% for 2023 and 2.5% in 2024, with downgrades being offset by upgrades to the US given its continued resilience and to some EMs such as India where growth has been stronger than expected.

  Chart 4:  US upgrades offset downgrades to the EU20 in terms of global GDP growth

  

  Source: Macrobond, Investec Economics

  Given signs that interest rates are beginning to restrain demand, and with inflation trending lower, the global tightening cycle looks to be coming to an end: the number of central banks hiking rates relative to cutting is at its lowest since May 2021. For the major G7 central banks cuts are not on the immediate horizon, but the majority are entering a pause with attention turning to how long rates need to remain at these restrictive levels rather than how high rates need to go. This we suspect will last into Q2 ‘24 before inflation and growth conditions merit some gradual loosening in policy from what are restrictive levels. Meanwhile, peak rates have already been seen in the likes of Brazil, where rates have been cut, with more to come. 

  Chart 5:  The net balance of central banks that are tightening is the lowest since May 2021

  

  Source: Macrobond, Investec Economics

  However a potentially complicating factor is energy. A decision by OPEC+, pushed by Saudi Arabia and Russia, to extend a 1.3m bpd cut in output to the end of 2023 has seen Brent rise 29%, breaching $95 for the first time since Nov-22. Whilst energy prices are volatile and prices could retreat again, particularly so if the high price level encourages US shale output to increase, they pose an upside rise to inflation. This comes at a time when the disinflationary base effects are ending, and energy is once again contributing positively to inflation. As such these latest developments could add to worries over ‘higher for longer’ policy rates, but that is not our baseline case.

  Chart 6: Energy prices represent a renewed inflation risk ($ per barrel)

  

  Source: Macrobond, Investec Economics, Bloomberg

• United States

  Last week as was expected the FOMC held rates at 5.25-5.50%. However this decision was accompanied by a firm higher for longer message, leading to markets interpreting this as a ‘hawkish hold’. This is seen most clearly in the dot plot, which shows a median view on the committee of one further rate hike this year, followed by 50bps of cuts next year (previously 100bps). But despite the higher rate profile, the economy seems to come away relatively unscathed, at least on the Fed’s projections, with GDP growth revised up both this year and next. One reason why growth may be so resilient to a higher rate environment is if the neutral rate of interest has drifted higher, as speculated by Chair Powell himself.

  Chart 7: FOMC thinks one more hike this year, higher for longer next, but jury out for 2025

  

  Source: Macrobond, Investec Economics

  We would agree with the Fed’s assessment that the US economy has been remarkably resilient over the past few months, particularly the consumer economy with the data hard to ignore. As such we have upgraded our own forecasts, boosting Q3 growth and removing our recession call. In spite of this we are still sceptical of the Goldilocks scenario that the Fed is projecting. Taking out a recession call is the matter of fractions of a percentage point - we still see stagnating output over the winter. There are still many headwinds to growth, the housing market is clearly struggling, and the resumption of student loan repayments should surely take the wind out of household consumption.

  Chart 8: Not all of the US economy is holding strong - mortgage approvals at mid-90s low

  

  Source: Macrobond, Investec Economics

  There is also a further downside risk arising from a potential government shutdown. At the time of writing, it appears that Congress will not pass the 12 appropriation bills that will fund the government in time to avert a shutdown on Oct 1. Hard-line Republicans unhappy with the spending deal struck by House Speaker McCarthy and President Biden during the debt ceiling negotiations are refusing to pass the appropriation bills without seeing large cuts to expenditure. If an agreement isn’t reached a continuing resolution could be passed to keep government funded, but this too seems unlikely currently. The last government shutdown cost the economy $3 billion, according to the Congressional Budget Office, shaving 0.2%pts off Q1’19 GDP.

  Chart 9: How has the economy fared in past government shutdowns? Small hit to GDP.

  

  Orange bars represent periods encapsulating government shutdowns.    
  Source: Macrobond, Investec Economics

  The potential government shutdown could also complicate matters for the Fed, as it would likely result in the ceasing of economic data releases during this time, meaning the Fed could enter the Nov meeting essentially blind. Either way, we maintain our view that the Fed has hit peak rates. The next logical question is then if rate cuts are around the corner. In the past there has been a circa nine month break between the last hike and the first cut and interest rates have been reduced quicker than they were lifted (Chart 10). But this is a different situation - we do not believe the Fed will be reacting to a deep economic shock as has been seen in the past, rather a preference to normalise policy.

  Chart 10: In past cycles typically Fed has cut more aggressively in first six months than hiked 

  

  *Sep 98 easing cycle only lasted three months
  Source: Macrobond, Investec Economics 

  Indeed, our view is the same, that as the economy cools and inflation dips lower next year, the Fed will no longer see the need for such a restrictive level of policy, resulting in a gentle easing. But considering where we are now and the Fed’s desire not to be caught out by inflation again, particularly considering the upside risks posed by the recent rise in fuel prices, we have pushed the first cut back by 3 months to next June. From here we think the Fed will cut rates at each SEP meeting, amounting to 75bps of easing in 2024. In light of this tweak in timing, we have inched up our dollar forecasts for H1, with earlier rate cuts no longer weighing on the USD.

  Chart 11: The US can no longer rely on favourable energy base effects to drag inflation lower

  

  Source: Macrobond, Investec Economics 

  There is also a growing financial stability risk to the US economy due to the build-up of leveraged short position in US Treasury futures. Hedge funds have been growing ‘basis-trades’ where the price differential between Treasury futures and the underlying instrument is exploited. This practice is not a risk per-se, what bodies such as the Fed, FSB* and BIS** are concerned about is the large positions and leverage involved – the spread between the instrument and the future tends to be small, so hedge funds are taking on huge amounts of leverage through the repo market to generate profits. The concern is that if there is a period of stress these positions may need to be unwound quickly, resulting in potential turmoil in Treasury and repo markets not unlike what was seen in March 2020 and September 2019.

  Chart 12: Leverage funds’ net short position in US Treasury futures sets alarm bells ringing

  

  *Financial Stability Board **Bank for International Settlements
  Source: Macrobond, BIS, Investec Economics

• Eurozone

  This month, we have downgraded our Eurozone GDP growth forecasts: we now predict growth of 0.4% in 2023 and 0.9% in 2024, 0.3%pts less than last month for both years. The newsflow has pointed to a definite loss of momentum. This is perhaps most stark in the PMI data, where the index level for manufacturing is now 43.4, its 15^th month below the neutral level of 50, and the services business activity index 48.4, the second month below 50. Noticeably, this illustrates that the downturn that began in industry in Q4 last year according to gross value added data is deepening, and that the hitherto resilient service sector (Chart 13) is now caught up in the malaise too. Even though the terms of trade have improved substantially now that gas prices are much lower, other negative factors have come into play.

  Chart 13:  GDP data show services resilient so far but industry to have contracted since Q4 ‘22

  

  Source: Eurostat, Macrobond, Investec Economics

  The obvious one is the monetary tightening that has taken place, which has slowed the economy by deterring borrowing. But in addition, the disappointing performance of the Chinese recovery has had an impact too. However, not all EU20 economies are affected to an equal degree. Germany stands out as having a particularly large share (6.8%) of its total exports going to China, the highest in the EU20 (Chart 14). It is therefore feeling the pain most acutely. Among the other ‘big four’ EU20 economies, France comes next (4.0%), followed by Italy (2.6%) and Spain (2.0%).

  Chart 14:  Germany has the highest share among the EU20 of goods exports that go to China

  

  *2022 average
  Source: Eurostat, Investec Economics

  The differentiated picture also reflects a rather varied experience at the household level of utility* price swings. Not only is the primary energy mix different, and the European gas market better characterised as regional rather than fully integrated, but governments have also taken quite different approaches to passthrough of the surge and subsequent partial unwind of wholesale gas prices to consumer utility bills. Chart 15 illustrates just how differently consumers’ utility bills have evolved. Italy (and the Netherlands) stand out as having been dealt a particularly challenging hand. Altogether, we now expect 2023/2024 GDP growth of -0.5%/0.4% in Germany, 0.8%/1.2% in France, 0.6%/0.7% in Italy and 2.2%/1.5% in Spain. Of these, Germany & Italy would be in technical recession.

  Chart 15: Household utility bills have evolved differently in the 5 biggest eurozone countries

  

  * Electricity, gas & other fuels
  Source: Macrobond, Investec Economics

  Much more in sync is the experience the various member states have had with respect to automotive fuel prices. Along with utility bills these make up the energy component of the CPI basket. The common factor here is the oil price, the world trade of which is more closely integrated, and where the link to petrol and diesel prices is much more direct (Chart 16). Like utility prices, automotive fuel prices surged in 2021 and H1 2022. Since then, however, they had trended down, explaining the bulk of energy price disinflation so far. Now that the oil price has risen again, that disinflationary impulse from automotive fuels will turn into a (mildly) inflationary one.

  Chart 16:  Automotive fuel prices are more closely linked to the oil price than utility prices

  

  Source: Eurostat, Macrobond, Investec Economics

  But even taking this into account, we expect inflation to maintain its downward trend: from 5.3% now. We forecast inflation to fall to 3.3% by Q4 ’23 and to 2.2% by Q4 ’24. The ECB’s forecasts are 3.3% and 2.9%. In delivering one more hike at this month’s meeting, the Governing Council chose to err on the side of caution and solidify its inflation-fighting credentials. But it balanced this with a dovish tone at the press conference – so much so that peak rate expectations did not rise around the meeting (Chart 17). We expect that, barring surprises in the data, the ECB is now done with hiking and will stress going forward its plan of restrictive rates being maintained for ‘a sufficiently long duration’.

  Chart 17:  A dovish hike: peak rate expectations did not increase despite the latest rate rise

  

  *14 Sep 2023, ** 13 Sep 2023
  Source: Macrobond, Investec Economics

  How long exactly that will be is inherently uncertain, but if the economy evolves as we expect, a less restrictive policy stance could be appropriate from mid-2024. We expect a Deposit rate of 3.25% by the end of next year. Given changes to our US forecasts, this would leave the scale and timing of Eurozone rate cuts next year similar to those in the US. The relatively stronger growth performance of the US economy and the aforementioned rise in oil prices could hold back EUR for now, but in the long run we do see US rates as having more scope to fall, which may help the euro to strengthen over time. By the end of this year, we predict EURUSD at 1.07, and by end-2024, we factor in a level of 1.12. Against GBP, we foresee levels of 86p and 89p, respectively (Chart 18).

  Chart 18:  A gradual strengthening in the Euro looks in store as 2024 progresses

  

  Source: Macrobond, Investec Economics

• United Kingdom

  CPI inflation surprisingly slipped to 6.7% in August from 6.8% in July, despite upward pressures from petrol costs and an increase in alcohol duty. Especially pleasing was a fall in service sector inflation which fell to 6.8% from 7.4%, helping to ease BoE fears of 'inflation persistence'. Upside risks here have not disappeared though. Wages are a critical factor in services costs and July’s labour market data showed private sector regular pay growth remaining elevated at 8.1% (3m yoy). Overall though we still expect CPI inflation to fall materially - our forecasts are 4.1% in Q4 2023 and 2.5% in Q4 2024. But we still recognise the upside risks from the labour market.

  Chart 19:  Inflation still heading downwards – are services less of a problem?

  

  Source: Macrobond, Investec Economics

  In a finely balanced decision, the MPC maintained the Bank rate at 5.25% on 21 September by five votes to four, with the dissenters backing a 25bp hike. The majority put less weight on the official pay data, remarking that it was not consistent with other (softer) evidence. In addition the QT gilt ‘envelope’ for the coming year was raised to £100bn from £80bn. Although it has not said so explicitly, the MPC is ‘data dependent’. With services inflation seemingly less of a problem and the committee disbelieving the strength of the official pay numbers our base case is now that rates have peaked. The yield curve sees a 60% chance of a final hike; less than three months ago, a terminal rate of c.6.50% was priced in (Chart 20).

  Chart 20:  Bank rate to fall faster than market expectations despite ‘Table Mountain’ profile?

  

  Grey area indicates forecasts
  Source: Macrobond, Investec Economics

  A key question is the relative weight the committee places on weaker economic prospects. The housing market is a case in point. As mortgage rates rebounded over the summer and as more households have refixed mortgages, cracks have reappeared after a brief reprieve. Nominal house prices according to the Nationwide and the Halifax are now 5% off their peaks, while surveys suggest no bottoming out soon. But UK housing market adjustments typically take place more via lower activity rather than calamitous falls in prices, especially in inflationary periods. Indeed housing turnover is down by 16% on a year ago, and mortgage approvals for house purchase by an even greater 22%. Lower turnover tends to be accompanied by less consumption, smothering GDP growth.

  Chart 21: Housing activity metrics are very soft, especially mortgage demand
  

  

  Source: Macrobond, Investec Economics

  GDP fell by 0.5% (mom) in July. This was distorted downwards by wet weather and strikes, but surveys, as well the housing market, point to softer activity after Q2’s +0.2% (qoq) growth as higher rates bite. For now, our GDP forecasts remain at +0.3% for 2023 and 0.0% for 2024 with a mild recession spanning the turn of the year. But a wildcard concerns revisions. The ONS has revised its GDP estimates: the level of output in Q4 2021 is now reckoned to be 2% higher than before. Data from 2022 will not be known until 29 Sep, but it is feasible that they too are stronger and that the UK is further from recession than it looks now. Another implication is that productivity growth has been higher through 2021 than first reported. If sustained, the MPC might be a little more tolerant of firm pay growth.

  Chart 22:  GDP levels for end-2021 were revised up by 2%. Will growth in 2022 and 2023 follow?

  

  Source: Macrobond, Investec Economics

  Attention may well soon turn to the next easing cycle. A common question is if the BoE tends to lower rates faster than it raises them. Chart 23 shows that since 1996, during the first six months of each rate cycle, it generally does. But this result was influenced by responses to various crises, which prompted aggressive cuts in rates. With the economy in recession and inflation falling sufficiently, our base case still sees rates coming down in mid-2024. But without (we hope) a major shock to the economy, and starting from very high inflation rates, we judge that the MPC will ease its policy stance at a more measured pace than it has tightened. In summary we are still projecting the Bank at 4.50% by end-2024 i.e .three 25bp reductions.

  Chart 23:  The BoE tends to cuts rates faster than it raises them (but not this time?)

  

  Source: Macrobond, Investec Economics

  The UK money market yield curve has shifted firmly downwards and become more negatively sloped over the past month but it is still pricing in less easing than our forecasts. From the point of view of our currency projections we have held the view that sterling could be vulnerable if and when the curve reprices. This has broadly played out with the pound slipping against both the dollar and the euro in recent weeks. We judge this may have further to run, envisaging sterling failing to participate much in a broader rally against the USD over the next 9-12 months, with cable stuck in the mid-$1.20s. But we now see sterling a little less weak against the euro at 86p at the end of this year. 
  

  Chart 24: Expectations of less support from interest rate differentials have led GBPUSD lower

  

  Source: Macrobond, Investec Economics

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