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Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett discusses the key focus point for the week ahead: what central banks are going to do next and the inflation trajectory.

13 June 2023

Although last week was a relatively quiet one in terms of information releases, there are two points we believe are particularly worthy of note. First, the data that was released was on the softer side, namely the US ISM Services PMI number which at 50.3 was barely an expansion. Notably, this is the part of the economy that has been providing strength in the US. In addition, the weekly jobless claims number was quite significantly higher. That is only a one-week observation but suggests we are seeing some slowdown in US growth. It is also notable that the euro area confirmed it has been in a technical recession for the past two quarters – only a -0.1% growth rate in Q4 2022 and Q1 2023, but bearing in mind the relief that we had avoided the worst in Europe because the energy situation was better than expected, that is quite a significant observation. Second, last week, both the Bank of Canada and the Bank of Australia raised rates, having previously paused their interest rate hiking cycle. That was a surprise but speaks to what will be a focus point this week: what central banks are going to do next and the inflation trajectory.

The first key release this week will be the US CPI number for May. The headline number could be close to flat but I believe markets will be focusing much more on the increase in core inflation which is probably likely to show that year-on-year inflation in the US is running at around 5%, which is still too high and will need to be addressed by the Federal Reserve (Fed) when it meets on Wednesday. We believe the most likely outcome is that the Fed will pause on Wednesday, but it will be a hawkish pause in which Chairman Powell is likely to emphasise that the Fed is not at the end of the rate hiking cycle, but rather that it wants to take some time out to see what happens on growth relative to inflation. The stickiness of core inflation, which can be observed in many of the major economies in the developed world at the moment, will need to be addressed. This will be the first key central bank meeting to focus on but there are others that we will be watching as they show divergence in the direction that central banks are currently taking.

The European Central Bank (ECB) will meet on Thursday and is likely to hike. Again, even though we are in a technical recession in Europe, the ECB is likely to raise rates by 25 basis points (bps) because of the stickiness of core inflation and we believe it will signal that it will continue to hike a little further. On 15 July we also have the Bank of China meeting, where we may see a rate cut given weaker data from China. It will be a key focus to see what the central bank does in terms of liquidity.

Finally, we have the Bank of Japan (BoJ) meeting. It is probably worth reminding ourselves that despite interest rates increasing in most places in the developed world, Japan is still running a negative interest rate. The Japanese economy is performing fairly well and inflation is probably higher than expected, but we would not expect to see any change in official interest rates. The BoJ is likely to maintain that negative interest rate and to move extremely gradually. We will be watching for any potential change the bank might signal on the corridor for yield curve control in Japan.

We will also see data released from China during the week, as well as retail sales in the US. Is all of this going to change the direction for equities? Perhaps not in the short term. We still have relatively well supported developed market equities, at least in the absence of materially bad information and that may continue in the short term. I think it is worth emphasising, however, that for the medium term the balancing act that central banks are trying to perform of engineering a growth slowdown in the face of the continued stickiness of inflation is still there and remains a challenge for them, which has not been resolved in any way, shape or form. We will see some significant signposting on how they are addressing that challenge over the next few days, which will be worth paying close attention to.

Important disclosures and information
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