Weekly view - Inflation: up like a rocket, down like a feather

Recent data has been confirming economies’ resilience and the need for central banks to keep tightening monetary policy. In the US, disinflation has slowed and the labour market remains very tight. The ISM survey of manufacturing, until now the weakest part of the economy, improved slightly in February, with a rebound in new orders. Worst (for the Fed), the prices paid subcategory rose above 50 for the first time in six months, indicating that US firms are paying more for inputs. In addition, growth in unit labour costs was revised sharply higher for Q4. Fed officials’ comments pointing to higher rates for longer could increase the risks for high-yield corporate bonds, where the share of low-grade B-rated debt in rating indexes is the highest in 10 years. We remain negative on high yield. On the corporate front more generally, evidence of pressure on margins and profitability is growing. Important to watch this week in the US will be Federal Reserve chairman Jerome Powell’s testimony to the Senate and the publication of February non-farm payroll figures. 

Labour costs are also a concern for the European Central Bank (ECB), with executive board member Isabel Schnabel judging probable wage growth as too high to be compatible with the ECB's 2% inflation target. Following numbers showing that core inflation rose from 5.3% to 5.6% in February, ECB president Christine Lagarde said that a 50bps hike in the ECB’s deposit rate this month was "very likely". We too expect the ECB to hike by 50 bps this month and again in May, with an increasing chance of an additional 25bps in June. Former ECB board member Otmar Issing said he expected wage increases to create a new inflation shock and that the ECB was late in reacting to underlying inflation. The signing of a EU-UK deal on the so-called ‘Northern Ireland Protocol’ is the first positive post-Brexit development. It came as figures revealed a big drop in UK housing transactions while house prices showed their largest annual fall in a decade in February. The Swiss economy flatlined in Q4 but grew by 2.1% over 2022 as a whole, displaying the country's resilience in a tough environment. Elsewhere, Italian GDP grew by a robust 3.8% last year but Sweden seems on the cusp of recession after GDP shrunk more than expected in Q4. One of our investment themes for this year is a preference for countries where fixed-rate debt is more prevalent, whereas in Sweden floating-rate mortgage debt predominates, exposing its government bonds and currency to weakness at a time of high and rising rates. 

Chinese purchasing-manager indexes for February were well above expectations. Nevertheless, we remain cautious about China’s economy beyond the short term, as much uncertainty still surrounds property prices, which is where many Chinese have their wealth tied up. The National People’s Congress this weekend decided to boost defence spending by 7.2% this year, showing a shift in priorities and potential stoking political tensions with the US.