Economy

A new report published by the firm’s top analysts on Wednesday said heavily-indebted Italy could be facing its highest debt bill as a percentage of its GDP since 2012 without ECB help, while Ukraine, Brazil, Egypt, Ghana and Hungary were the most vulnerable emerging market countries.”Rising rates look to be fiscally challenging for a minority of developed market sovereigns and at least six out of 19 emerging market sovereigns”, S&P’s report, which assumed that borrowing costs would increase by around 300 basis points in the next three years, said. More

Seems we’re at the stage of the sell-off where analysts turn Homeric. Here’s the latest from Goldman Sachs’ commodities desk: Macro markets today are facing a navigational challenge worthy of Odysseus. In the Greek myth, Odysseus chose to risk his ship by sailing close to the rocks of Scylla rather than risk being pulled under by the whirlpool Charybdis. In our view, policymakers are trying to navigate between the Scylla of high physical inflation today, and the Charybdis of supply constraints that could slow future growth. While it appears that much higher rates are needed today to lower demand and inflation, they may also drive a fall in capex and investment that will prolong the structural undercapacity in physical commodities and hence this environment of high headline inflation and lower growth throughout the 2020s. We believe that promoting higher investment in capacity – and bearing Scylla’s cost of higher physical inflation today – can policymakers avoid the Charybdis of stagflation. As in the myth, staying close to Scylla’s cave is mild as Odysseus would suffer minimal damage (ie keeping rates lower, leaving prices higher to drive investment); however, if his ship is sucked down by Charybdis (a decade of stagflation after high rates kill off the capex cycle), he would lose his entire ship. It is important to emphasise that policymakers can solve the core inflation problem without entirely fixing the headline inflation problem given the importance of persistent wage inflation in driving core inflation. Goldman’s commodities team concludes that Goldman clients should buy commodities. A decade of under-investment in carbon extraction means the complex “can still generate returns even should core inflation return to more normal levels”, it says:Investors should remember that Fed-induced slowdowns are simply a short-term abatement of the symptom – inflation – and not a cure for the problem – under-investment. More broadly, when macro imbalances are physical and supply-driven, financial-based macro policies surrounding demand cannot resolve them, only co-ordinated investment policy can. With central bankers now focused on the costs of high inflation, there is a risk that the long-run cost of too deep of a recession is the end of the capex cycle and a failure to grow sufficient capacity to debottleneck the system. When Volcker took the Fed Funds Rate to 20 per cent in 1980, it was after a decade of rising capex, allowing the subsequent fall in demand in the space to debottleneck global supply chains.

In the current environment, the ‘capital-heavy’ capex cycle has barely begun and is at risk f rom a recession or resumed only through a return of physical inflation after growth resumes. Crucially, because the Fed looks to lower inflation at the lowest cost to the economy, most Fed-induced recessions are mild, and allow the capex cycle to continue, as was the case pre-Volcker in the 1970s.

The counter argument comes from Albert Edwards at SocGen, whose notes can often make Greek tragedy look like light relief. Predictions of a Fed-guided shallow recession are a “normal spurious landmark we pass at this stage in the cycle before all hell breaks loose and both the economy and markets collapse”, he says. As evidence Edwards cites the New York Fed’s own forecast briefing of June 17 that put the chances of a hard landing at “about 80 per cent”:Perhaps the more interesting question is not how deep the recession will be, but how large the fall in yields will be? The recent inflation surge broke the close link between the real economy data and bond yields. Will a recession dispel inflation fears (temporarily) and drive bond yields substantially lower?

A hard landing for the US economy would force the Fed to capitulate, though sky-high inflation would make a full policy reversal unlikely. But what if inflation dissipates quickly? Edwards points to copper’s 15-month low and highlights that cyclical carbon commodities were laggards during the GFC collapse:

If (when) the oil and agricultural complex joins this bear market, headline CPI inflation could quickly collapse to below zero just as it did in 2008/9 when headline CPI fell from +5% to -2% in just 12 months. A similar fall into negative inflation would likely take bond yields substantially lower, even if core CPI stays sticky above 2%. Although a sub-1% 10y yield seems to me entirely plausible, I suspect we won’t now see a fall below the March 2020 0.3% low as the secular Ice Age trend of lower lows and lower highs in each cycle is broken. The new secular trend may now be for higher inflation and higher yields, but a cyclical recessionary shock awaits. More

Overall consumer price inflation hit a fresh 40-year high of 9.1% in May, as rising food costs – especially for bread and meat – took over from surging energy prices as the main driver of the latest increase in CPI.While Russia’s invasion of Ukraine is disrupting supplies of grain and vegetable oil, food prices more broadly have been pushed up by poor weather and rising energy prices, which increase the cost of fuel, shipping and fertiliser. Food and non-alcoholic drinks prices paid by consumers in May were 8.7% higher than a year ago – their biggest increase since March 2009 – and manufacturers’ ingredient costs are rising even more rapidly.The prices manufacturers paid for domestic food materials is up 10.3%, while imported food costs – which account for almost half Britain’s consumption – were 20.5% higher, the largest rise since December 2008.”Food inflation overshot our forecasts. We now expect price growth here to peak at a little over 20% in Q1 2023, with producer price inflation here continuing to accelerate,” Citi economist Benjamin Nabarro wrote in a note to clients.Last week industry forecasters the Institute for Grocery Distribution (IGD) predicted food price inflation would peak at 15% in the coming months, and said some households were already skipping meals.Surging food prices are a particular concern for Britain’s poorest households, who spend a higher proportion of their income on meals. Supermarkets have reported shoppers trading down to cheaper ranges.Citi said the visibility of rising food prices was also likely to put greater upward pressure on wage demands than other types of inflation – a concern for some officials at the Bank of England who fears big pay rises might entrench inflation. More

In China, pork prices determine inflation rates. The meat is a local staple and has the largest weighting in food costs. A price rally that started earlier this year is continuing. Food producers may have to pick up the pricey tab.Hog prices have risen nearly 40 per cent since March, pushing wholesale pork prices up a fifth. That is a big impact on the economy. China consumes half the world’s supply of pork. As lockdowns in key cities such as Shanghai ease, the pick-up in consumer demand should far outpace the increase in supply that would come from normalising operations at factories and in logistics.For local hog producers and pork-related companies, including Muyuan Foods and Zhengbang Technology, this surge in demand is not necessarily a good thing. Grain prices have soared, adding pressure to margins via pig feed. A decline in the number of breeding sows has accelerated since last year. Operating margins at hog producer Muyuan turned negative in the year to March, a sharp contrast from fat margins of more than 50 per cent in 2020. Given the importance of pork prices in keeping inflation below the government ceiling of about 3 per cent, it will not be easy for food companies to quickly pass on rising costs to consumers — even without explicit pressure from Beijing. Shares of local hog producers and pork-related companies have long been a stable source of returns. That is changing. Shares of Muyuan are down a quarter. Feedstuffs maker Zhengbang has fallen 54 per cent in the past year, reflecting rising costs. The latter already operated on slim single-digit operating margins before Russia’s invasion of Ukraine, which has since pushed up grain prices. Zhengbang now runs on negative margins far worse than those of Muyuan. China’s consumer prices rose 2.1 per cent in April. That is low by the standards of the US or UK, awash with stimulus money, but more than double the 18-month average. As prices of energy and grains remain high, the current trend in pork prices could soon push China’s inflation out of Beijing’s comfort zone. More

LONDON (Reuters) – The financial sector should not bet on remaining deadlines changing for the phasing out of the use of Libor interest rates, Britain’s Financial Conduct Authority (FCA) said on Wednesday.Helen Boyd, head of markets policy at the FCA, said the market had “categorically proven” it can ditch the London Interbank Offered Rate or Libor, a widely used rate tarnished after banks tried to rig it.The bulk of contracts such as mortgages, credit cards and business loans pegged to Libor, which was compiled across five currencies, were phased out by the end of 2021.Phasing out Libor, one of the biggest market changes in decades, felt like an “anti-climax” given it went so smoothly, Boyd said.Contracts are being transferred to interest rates compiled by central banks like the Federal Reserve, Bank of England and European Central Bank based on market transactions and seen as far harder to rig.Outstanding dollar Libor contracts must be phased out by the end of June 2023, and since the end of 2021 the rate can no longer be used in new contracts.”Don’t expect the deadlines to change,” Boyd told an event held by the derivatives industry body ISDA.There were contracts worth about 30 trillion pounds ($37 trillion) linked to sterling Libor at the start of 2021, but this has been whittled down to just 1% of that figure, Boyd said.The FCA has allowed the use of a “synthetic”, temporary form of Libor for yen and sterling contracts to aid transition to central bank rates for so-called “hard legacy” contracts.The FCA will hold a public consultation in coming weeks on winding down these synthetic rates, she said.”We have been clear that synthetic rates will not be continued simply for the convenience of those who could take action, but don’t,” Boyd said.No one should be relying on the creation of a synthetic dollar Libor rate after June 2023, she added.($1 = 0.8172 pounds) More

Workers in Emden, Bremerhaven, Bremen, Brake, Wihelmshaven and Hamburg were called on to take part, after a fourth round of wage negotiations fell through. The union is demanding a pay rise of 1.20 euros ($1.26) per hour and inflation compensation over 12 months for some 12,000 workers.The union had already called for temporary work stoppages to increase the pressure on employers at the start of June.Ports are already clogged up as import containers are not being picked up and slots are in short supply, forcing shipping companies to go off schedule.According to the Hamburg coordination office, half a dozen container ships are waiting to dock in Germany’s bay alone.Industry experts expect the situation on the North Sea coast to worsen in the coming weeks, as many ships are on their way to Europe following the end of the lockdowns in China.($1 = 0.9517 euros) More

The U.S. economy is heading for a hard landing, and a recession is coming within 12 to 18 months, wrote former president of the Federal Reserve Bank of New York, Bill Dudley, in an opinion column for Bloomberg Economics.Dudley noted that the Fed’s latest set of projections laid out a benign scenario amid rising interest rates, but he sees several reasons to expect a “much harder landing.”The central bank’s employment mandate is now subservient to its inflation mandate, and the new focus on price stability will be “relentless.”“Fed officials recognize that failing to bring inflation back down would be disastrous: Inflation expectations would likely become unanchored, necessitating an even bigger recession later. From a risk management perspective, better to act now, whatever the cost in terms of jobs and growth. Powell does not want to repeat the mistakes of the late 1960s and the 1970s,” wrote Dudley.It will take time for considerable monetary policy tightening to have an effect, but the economist thinks the expansion is uniquely vulnerable to a sudden stop. As inflation outstrips wage growth, the personal savings rate has plummeted, from 26.6% in March 2021 to 4.4% this April, significantly below its long-run average.“No wonder consumer sentiment has fallen to levels last reached in the aftermath of the 2008 financial crisis, and Google searches for the word ‘recession’ are hitting new records,” he added.Dudley concluded, “The Fed has never tightened enough to push up the unemployment rate by 0.5 percentage point or more without triggering a recession … Much like Wile E. Coyote heading off a cliff, the US economy has plenty of momentum but rapidly disappearing support. Falling back to earth will not be a pleasant experience.” More

BEIJING (Reuters) – China will step up support for automobile consumption and expects vehicle and auto-related consumption to increase by about 200 billion yuan in 2022, state media reported, citing a regular cabinet meeting on Wednesday.China is also considering extending a purchase tax exemption for new energy vehicles, the meeting, chaired by premier Li Keqiang, said. More