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August 11, 2022

Inflation worries linger – from the UK to Indonesia

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Julius Probst
Arnaud Lieugaut
Patrick Malm
Karl-Philip Nilsson
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UK stagflation forecast to become reality

The Bank of England is forecasting a bleak outlook for the UK. This four-year chart shows the central bank’s forecast for a spike in inflation – which it expects to top 12% by the end of the year – coupled with negative or flat economic growth throughout 2023. The unemployment rate is expected to increase from less than 4% to more than 6% in two years’ time. The aftermath of the pandemic and the global commodity price shock are contributing to this stagflationary outlook – with several economists pointing to Brexit’s impact on the labour market as a contributing factor.

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Indonesian food costs push inflation higher

Consumer prices are surging around the world, but Indonesia has enjoyed relatively subdued inflation compared with many advanced economies. Until several months ago, the consumer price index (CPI) remained below the upper limit of the central bank’s inflation target (which is centered around 3%). However, the last two months have seen the CPI surge above 4%. This chart shows how food price inflation is the most notable culprit.

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Emerging markets under stress as higher rates boost debt burden

Emerging markets are often the first casualties when the Federal Reserve starts a tightening cycle. Rate hikes by the Fed and other central banks are negatively affecting the fiscal outlook for many such countries. This chart shows interest payments as a percentage of GDP are surging for nations including Turkey, Indonesia, Mexico and Brazil.

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US productivity a negative outlier amid positive economic data

In a series of charts last week, we cast doubt on the thesis that the US was in a recession during the first half of 2022. However, one recent data point contradicts the other evidence: employees are working more to produce less. This chart shows one of the largest declines in labour productivity recorded in recent decades.

According to research from the Peterson Institute for International Economics, productivity data is very hard to measure, and the recent record divergence between gross domestic income (GDI) and gross domestic product (GDP) might imply that productivity has not fallen nearly as much as recent figures suggest. GDI is a measure of economic activity based on the money earned for goods and services produced, and hourly compensation spiked during the early stages of the pandemic (ultimately to be passed on to consumers via price inflation).

It may take six to 12 months, or even longer, for data revisions to confirm whether we are truly seeing a huge productivity decline, or whether that data point is an outlier untethered from economic reality.

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The ECB is targeting Southern European asset purchases (again)

The European Central Bank’s new Transmission Protection Instrument (TPI) has the explicit goal of preventing a surge in bond-yield spreads for Southern Europe akin to the debt crisis of 2011-12. (This is particularly in focus as Italian government debt is higher as a proportion of GDP than it was during the crisis a decade ago.)

This chart based on net asset purchases shows how the ECB‘s stockpile of German government bond holdings is currently going down as a fraction of German bonds on the ECB’s balance sheet is maturing each month. Southern European holdings, on the other hand, are still increasing as the ECB is targeting reinvestments from the asset purchase programs towards Southern European countries with higher yields. This remains politically very controversial in Northern European countries.

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Could TARGET2 balances suggest stress in banking systems?

This chart shows the expansion of TARGET2 (Trans-European Automated Real-time Gross settlement Express Transfer system) 2 balances – the net claims and liabilities of national central banks vis-à-vis the ECB that arise through cross-border payments settled in the central bank’s funds. They reflect banking flows between different nations.

For instance, when the Spanish central bank buys government bonds on behalf of the ECB from investors with a bank account in a different country, either inside or outside the euro area, that cross-border transfer would show up in the target balances as a liability for Spain. Conversely, when Germany’s Bundesbank receives more money than it is sent, it would record a positive target balance.

A significant contributor to higher TARGET2 balances is the ECB’s large-scale asset purchase programmes – firstly, after the European debt crisis, and now again following the pandemic. (Note that some of the TARGET2 trends simply reflect the fact that so many investors have bank accounts in the financial centres of Frankfurt, Luxembourg and Amsterdam.)  

However, outflows from one national banking system to another could also be a symptom of increased financial stress.

It’s important not to assume a direct link between TARGET2 balances and heightened risks to the currency union. Instead, one should unpack the reasons why cross-border claims and liabilities are increasing.

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Hedge funds providing protection (relatively) in 2022

Hedge funds historically sought to “hedge” market risk, and most strategies have done just that in 2022 by outperforming equity benchmarks. This chart compares the returns from various hedge-fund strategies to the performance of the S&P 500. Note the large divergence between different strategies: macro hedge funds are the only ones that are in positive territory, while fixed income credit funds have suffered by almost as much as the benchmark equity index  during this year’s global bond market selloff.

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China trade balance reaches new high

This chart shows that China’s trade surplus has surged above USD100 billion for the first time. This export strength contrasts with the general slowdown in the economy, as a deflating real-estate market is depressing domestic consumption and thus imports as well.

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Tourists return to Thailand

Thailand experienced rapid tourism growth before Covid-19, with the number of visitors roughly doubling between 2010 and 2020. The pandemic put a complete stop to that. This chart of monthly visitors to the southeast Asian nation shows how the sector is finally recovering: the number is surging back towards one million – though that’s still just 25% of the pre-pandemic volume of tourists.

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