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September 8, 2022

Central banks and asset markets assess inflation

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Julius Probst
Arnaud Lieugaut
Patrick Malm
Karl-Philip Nilsson
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Another Chinese city grinds to a halt

There’s more bad news coming out of China, which is shutting down more cities due to its strict zero-Covid policy. This is weighing heavily on the Chinese economy. And a slower Chinese economy means slower global growth.

Even before the current wave of lockdowns, China was forecast to grow only about 3% this year, according to the IMF. That would be the slowest pace in 40 years.

Our first chart tracks plummeting road and rapid-transit use in Chengdu, the mega-city that recently had its lockdown extended indefinitely. More urban areas could follow, as our second chart shows: an increasing number of regions are being classified as medium- or even high-risk areas for Covid-19 outbreaks. 

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August and September are a season of underestimated NFP job growth

Like a writer’s first draft, economic data reports are meant to be revised. Statisticians reconsider their initial estimates and provide a more accurate figure months later. 

In the case of the key nonfarm payrolls (NFP) figure, these revisions usually seem to cancel each other out over time. That means for most months of the year, there is no persistent bias, or seasonality, in the NFP number.

But there is an exception to that trend, as the following chart shows. August, and to a lesser extent September, have a history of undercounted job growth, according to our chart of monthly data from January 2000. Revisions to NFP for August are usually positive, with a mean upward increase of 40,000. 

Don't miss our most recent blog, which saw our in-house economist, Julius Probst, PhD, use Macrobond and Indicio Technologies to construct a NFP super-forecast for stronger-than-expected job growth that was more on-target than every major bank’s prediction.

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Unemployed Americans increasingly have not been unemployed that long

Our analysis has repeatedly suggested the US economy was not in recession during the first half of the year, and that the two negative prints of GDP growth were probably incorrect (i.e., will likely be revised) for technical reasons. 

The extremely tight US labour market over the past year supports this argument. The chart below segments the unemployed by the length of the time they have been out of a job. After the initial disruption from the pandemic, the data show a steady decrease in the proportion of the longer-term jobless among those looking for work.

Or to put it another way, the proportion of the unemployed who have been out of work for only a short time (less than 14 weeks) is now at its highest since the 2008 financial crisis, hovering near levels seen in the mid-2000s – a period where some economists consider the US economy to have been operating at full employment. 

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How investing differs when the inflation regime changes

This year’s inflationary spike changed the environment for investing. Many market participants have only experienced a world that assumed inflation was very low and would stay that way. 

The following chart, using data going back to 1987, shows the average monthly returns for commodity, stock and bond indices under different inflation “regimes:” high and rising, low and falling, and several scenarios in between.

As expected, falling inflation is usually better for returns than rising inflation. For the stock market, it’s historically best when inflation is low and declining.

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Real estate prices by GDP growth and inflation regime

One can also apply the “inflation regime” treatment to real estate. While property is sometimes viewed as an inflation hedge, performance varies depending on the growth environment.

The following chart uses US real estate data dating back to 1970 to delineate nine different growth/inflation environments during that time period. Growth and inflation regimes are split using the 33rd and 66th percentiles.

Unsurprisingly, real estate does not do well when growth is slow. But it performs the worst when inflation is high amid a low-growth environment. The best price performance happens during a high-growth, high-inflation boom.

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Central bank balance sheets are shrinking

Central banks’ balance sheets started shrinking in 2022 as policy makers embarked on a major tightening cycle to combat soaring inflation. This policy has probably contributed to the correction in asset prices.

The following chart shows the year-over-year change to the balance sheet from all major central banks. It’s notable that the Covid-19 response – a massive USD 10 trillion from all central banks combined over the course of a year – was an order of magnitude larger than the quantitative easing that followed the 2008 financial crisis.

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A dearth of doves on our central bank tracker

The following dashboard tracks the central banks of G20 and OECD economies, showing each country’s policy rate as well as the most recent decision to cut or hike rates. With the notable exceptions of China, Russia, Turkey and Japan, every other economy has been tightening policy. 

Moreover, most countries have been hiking rates within the past two months, showing how monetary policy is globally synchronized.

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The market believes the Bank of England will hike more than the Fed

Bank of England Governor Andrew Bailey has said that as inflation tops 10 percent, his institution must respond to one of the biggest shocks it has ever faced. Futures markets believe that response will be a tightening cycle that outpaces the Federal Reserve.

The following chart displays the trajectory of policy rates for the Fed, BOE, and the ECB since 2021. It then plots those rates’ future as financial markets see them. Markets are pricing in hikes for all three economies through the rest of 2022 and into mid-2023. 

Rates are expected to peak at almost 4.5 percent in the UK. That compares with almost 4 percent in the US, and only 2.5 percent in the eurozone. Futures also forecast slowly falling rates from mid-2023 – anticipating a major slowdown and probably a recession, at least for the Eurozone and UK. The US still has the highest odds of pulling off a soft landing.  

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Indonesians up in arms as a squeezed government raises fuel prices

Indonesia has subsidized petrol prices for decades. With oil prices soaring, and Indonesia a net fuel importer, this policy was proving costly. 

The government recently raised prices by about 30 percent. Unrest quickly ensued as the local cost-of-living crisis sparks anger on the streets.

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