What does the chart show? 

This chart shows the foreign currency reserves for the UK, Japan, and China in US Dollar terms. Foreign currency reserves are very important to a country’s economic health. Commodities are often priced in dollar terms and so dollars are needed to purchase them. When trading with foreign nations, having a store of their currency is necessary to purchase their goods. Central Banks hold foreign currencies that importers can exchange into local currencies to import foreign goods. A country with a negative balance of trade needs foreign currency reserves to pay for its imports. The store of foreign currencies can also be used by a central bank to stabilise the price of their own currency. If a local currency is devaluing heavily against another, then a central bank can sell their reserves of the foreign currency bringing the price of its own currency up. Japan and China are both examples of countries that have recently manipulated their own currencies in some way. Their large reserves of over $1.1 trillion and $3 trillion respectively have allowed them to do this. In comparison, the UK’s foreign currency reserves sit at just $110 billion. 

Why is this important? 

Currency valuations have been thrown into the spotlight in recent months. Global uncertainty and the frontloading of interest rate hikes by the Federal Reserve have led to significant inflows of capital into the US. The US Dollar has surged in value at the expense of other currencies reaching parity with the Euro for the first time since 2002 and pushing the value of the Yen down to as low as ¥145 per dollar. In the UK, the release of new Chancellor Kwasi Kwarteng’s so called ‘mini-budget’ saw the value of the Pound drop sharply to as low as $1.033. Although the value of the pound has been gradually falling in recent months, the sharp drop is unlike anything that the Pound has experienced before. There is now an expectation that some sort of intervention may be needed to stabilise the currency. The Bank of England (BoE) has already shown its willingness to intervene in markets to limit volatility with its purchases of long-term gilts. However, when compared to historical examples of currency interventions, the BoE’s options are limited. Just last week, the Japanese government intervened to halt the slide in the value of the Yen. In a one-off move, a bulk sale of Dollars for Yen saw the price of the Yen rise to ¥141 from ¥145 against the Dollar. Although the interest differential between the two countries means that downward pressure on the Yen is maintained, the move could offput some speculators who have helped drive down the value of the Yen. China’s vast foreign currency reserves have allowed it to limit volatility in its own currency through moderate levels of intervention. The UK’s large current account deficit and smaller currency reserves mean that they are less able to intervene in the same way that Japan and China have in the past. Instead, the BoE may resort to other measures. With the next Monetary Policy Committee meeting not until November, markets have priced in an unprecedented 150 basis points rise of the BoE rate with some suggesting there could be an emergency rate rise before then. A dramatic rise in rates increases is likely to contribute further to an economic slowdown further down the line. Already facing high inflation and now battling the risk of a spiralling currency, the BoE has a difficult task ahead.

What does the chart show?
 This chart shows an aggregation of the yield-to-worst (YTW) of US corporate credit. The YTW is the lowest possible yield that can be received from a bond without it defaulting. Companies can redeem or ‘call’ their bonds, returning the initial amount borrowed to the lender before the previously agreed maturity date and the lender will no longer receive the future coupon payments. The YTW is the amount of yield a lender would receive if the bond was ‘called’ as soon as possible. Demand for US corporate credit has fallen sharply in recent months and the inverse relationship between the price and the yield on bonds has meant that yields have risen sharply in response. Yields are currently 5.14%, above what they were during the earliest stages of the Covid-19 pandemic and at levels not seen since the Global Financial Crisis (GFC).

 Why is this important?

 Corporate bond prices and yields can be a good indicator of the market’s confidence in a company or the economy as a whole. When confidence is high, investors are willing to lend money to firms at lower rates, confident that they are unlikely to default. Many investors hoped that the healthy balance sheets and strong cash reserves that firms built up over Covid-19 would see them through the expected economic slowdown. However, persistently high inflation and rising rates have meant that firms are burning through record amounts of cash. Fears of a recession continue to grow and the outlook for firms becomes bleaker. Lending to firms is now riskier and companies have been forced to offer better rates to attract financing for their debt. Demand for bonds has collapsed, and the prices have fallen so yields have soared. However, although yields are currently at levels not seen since the GFC, the spreads between corporate and treasury yields tell a different story. The yields on risk-free US Treasuries have also risen this year and while the spread between the two has increased to around 150bp; it is only slightly above its 10-year average of 133bp. By comparison during the pandemic, corporate bond spreads rose above 400bps. Today’s lower levels could indicate that while there are certainly rising levels of caution surrounding corporate debt, this is more based on macroeconomic uncertainty rather than a widespread fear of default that drives corporate debt spreads. Therefore, while US corporate bond yields are rising at a rate that shows no signs of slowing investors can still have reason to be optimistic about US companies’ ability to survive what is predicted to be a difficult period ahead.

What does the chart show?

This chart shows US year-on-year Consumer Price Inflation (CPI) and the level of US unemployment since 1950. Inflation in the US has recently been at its highest level in around 40 years with the latest data from August putting year-on-year inflation at 8.5%. Alternatively, unemployment in the US has reached as low as 3.6% following a sharp recovery from the record levels of unemployment seen during the Covid-19 pandemic. Inflation and unemployment have always been linked, with periods of high unemployment often coinciding with lower levels of inflation and vice versa. 

Until the 1970s this link was seen to be causational with economic expansions driving up prices, encouraging businesses to grow and hire more employees. This idea was disproved in the late 1970s when expansionary fiscal and monetary policy was used to try and bring down high levels of unemployment in the US. However, rising prices and declining confidence instead produced a combination of higher inflation and unemployment that only a federal funds rate as high as 19% and a difficult recessionary period could bring under control.

Why is this important?

The relationship between inflation and unemployment is extremely relevant to the situation facing the US economy today. With the Fed making tackling inflation its number one priority, US jobs data is one indicator as to how effective the Fed’s strategy is proving to be. Although the relationship is not causal, historical data suggests that inflation does not tend to peak until labour markets show signs of loosening. The Fed has a mandate to keep unemployment low, but a tight labour market can lead to a wage-price spiral; which, when combined with global macro events such as supply chain issues and the Ukraine-Russia crisis, has contributed to the persistent levels of inflation. 

The Fed faces a tough balancing act between acting too strongly and strangling economic growth, and not acting strongly enough and allowing high inflation to persist. The US labour market has shown some early signs of cooling in response to the Fed’s more hawkish policy but still remains tight. Several similarities can be drawn between the current situation and the stagflationary period of the late 1970s. High oil prices have driven up inflation, and the US now faces a fall in confidence and a stagnation of economic growth. Rising interest rates combined with persistently higher prices may now result in a stagflationary period in the future. In the 1970s, the Fed acted decisively to tackle the issue inflicting a recession in the process. There are some who believe that the Fed must have its own ‘Volcker moment’1 if it wants to effectively deal with the issue. 

https://en.wikipedia.org/wiki/Volcker_Rule

What does the chart show? 

This chart shows the price of the Euro against the Dollar over the past three years. The price reflects the markets demand for Euros relative to the Dollar. Following steady declines since its peak at $1.58 back in 2008 and a more recent peak of $1.22 at the end of 2020, the price of €1 dropped below $1 for the first time since 2002, reaching a two-decade intraday low of $0.9934 early last week. With a strong Dollar and the Euro steadily weakening, the reaching of the parity level between the Dollar and the Euro is largely seen as symbolic. Minor currency fluctuations are caused by changes in an economy’s balance of trade or by high levels of inflation. However, the decline in the strength of the Euro can also be seen as indicative of future expectations for the economic performance of the Eurozone as a whole.  

Why is this important? 

Over the past six months, Europe has grappled with the effects of the Russia-Ukraine conflict. Inflation has hit record levels and is expected to remain high, as gas prices have reached record levels. Fears of a complete shutoff of Russian gas in response to European sanctions over the country’s invasion of Ukraine have forced many countries to implement plans to ration energy usage over the winter months. High inflation, a cost-of-living crisis and fears of a global economic slowdown have given rise to a stagflationary environment in Europe. Political instability in Italy and a gloomy outlook for the Eurozone area have also contributed to higher uncertainty, causing outflows of money from Europe to the Dollar which has historically been seen as a haven during periods of uncertainty. The European Central Bank (ECB) recently raised rates for the first time since 2011 with a 50-basis point hike that surprised many onlookers, but the pace of its rate hikes has lagged behind those of other major central banks causing outflows as savers search for more attractive returns on their cash. Speculators have predicted further declines in the Euro’s value with a net short position of 44,100 futures contracts being built up. Should the currency continue to decline, it may exacerbate the high levels of inflation by increasing the costs of imports, further damaging Eurozone consumer confidence which already sits below levels seen during the Covid-19 pandemic. However, with further ECB rate hikes expected and early indications that the continents energy crisis may not be as dramatic as previously feared, there is a chance that the widespread money flows away from the Euro could reverse and the currency could stage a recovery in the long run.

What does the chart show?
 
This chart shows the JP Morgan Emerging Markets Bond Exchange Traded Fund (ETF) over the past five years. The ETF tracks the performance of US dollar denominated government bonds issued by over 30 different emerging market countries such as China, Mexico, and Indonesia. The ETF gives an indication of the market’s confidence in the economies of emerging markets (EM) and can be used by investors to gain exposure to emerging market debt. The increased economic and political risks that are associated with emerging markets mean that yields on emerging market debt tend to be higher than in developed markets for governments to attract the necessary financing of their debt. As demand falls for EM debt, the inverse relationship between the price and yields of bonds means that borrowing becomes more expensive. Demand for emerging market bonds has collapsed over recent months with the ETF down 18% year-to-date, levels not seen since the early stages of the Covid-19 pandemic.

 Why is this important?

 Global macroeconomic factors have combined to produce an almost perfect storm that poses strong economic headwinds to emerging markets, spooking investors. With the Federal Reserve sharply raising rates to tackle inflation and with the growing risks of a potential recession, capital outflows from emerging markets to developed markets, such as the US, have been significant. The trade-weighted dollar index currently sits at its highest level in nearly two decades. A stronger dollar, as well as higher oil and food prices has drained the foreign exchange reserves of several countries leading to significant economic turmoil. Earlier this year, Sri Lanka defaulted on its debt repayments as the country’s government was overthrown. Pakistan and Ghana also face liquidity crises with bond yields spiralling higher, and both countries are now looking to their creditors and the International Monetary Fund for support. Emerging market assets are extremely sensitive to economic and political turmoil and the dramatic decline in demand for emerging market bonds serves as an indicator for a difficult global economic situation. However, there are suggestions that the outlook for emerging markets is not as bleak as previously feared. Although many economies are facing difficulties, default rates are not expected to rise significantly. Markets may have already priced in the expected economic turmoil and many EM countries are on a sounder financial footing than during previous monetary tightening cycles. Investors willing to ride out short-term volatility may see emerging markets as a longer-term opportunity.

What does the chart show? 

The chart shows US two, five, ten, and thirty-year inflation breakeven rates, derived from the difference between conventional and inflation-adjusted government bond yields of the same maturity. Their values indicate what market participants expect inflation to average annually over the next two, five, ten, and thirty years. It is coined the breakeven rate as it refers to the average level of inflation that would be needed to make an investor indifferent between buying an index-linked bond, or a nominal bond. If an investor thinks inflation will exceed this breakeven rate over the period, they will buy the inflation-linked bond; contrastingly, if inflation is not expected to hit this level, they will buy the nominal bond. Breakeven rates in the US have fallen from their highs earlier this year in a sign that investors are moving to price in lower inflation for the years ahead.  

Why is this important? 

US data indicated that whilst still elevated on an annualised basis, inflation showed signs of slowing. For July, the Consumer Price Index (CPI) reading came in flat at 0% month-on-month and the core equivalent rose by 0.3%, both readings came in lower than analysts’ expectations. Investors reacted positively to the release, with some relief that the worst may now be behind us, looking beyond the economic slowdown. However, Fed officials remain determined to wait for prolonged cooler inflation, defending the central bank’s aggressive hikes, before any change in outlook. The timing and the path to a normalised environment remain uncertain, with the sticky elements of inflation remaining elevated. Unlike the Global Financial Crisis, this cycle is not driven by the need for financial deleveraging, and the balance sheets of households, businesses, and banks are generally strong. This will help to minimise the slowdown ahead and gives the scope for economies to bounce back quite quickly. At the same time, valuation opportunities have emerged for longer-term investors. With careful diversification, we believe it is important to take advantage of setbacks in markets, as the cycle evolves and ride out any short-term volatility to participate in full, in those longer-term opportunities.

What does the chart show? 

The chart shows China’s trade balance (level of exports minus the level of imports) over the past seven years. China is the largest exporter in the world by value and has historically operated at a trade surplus. During the pandemic, an aggressive zero-Covid policy saw the complete lockdown of many of China’s most productive cities, such as Shanghai and Shenzhen. This led to a collapse in export levels and the country fell into a trade deficit. Since then, export levels have recovered strongly, but with the Chinese government still pursuing its zero-Covid policy and with major production hubs moving in and out of lockdowns, the trade balance has fluctuated wildly. However, the most recent data released in July saw the level of exports surprise significantly to the upside, with China’s trade balance rising to an all-time high of $101.3 billion, breaking the record set in June. 

 Why is this important?

 With tensions rising between China and the US in the aftermath of US House Speaker Nancy Pelosi’s visit to Taiwan, China’s position on the global stage has been thrust into the spotlight. Many believe that China is now able to challenge the US both economically and militarily, and the country’s sizeable trade surplus may support this, having a large trade surplus can be an indicator of a thriving economy. Higher levels of exports boosts growth and employment within an economy, both of which are desirable for a country, and China’s surplus far outweighs the US deficit of almost $80 billion. 

 The lockdown of Chinese factories saw US consumer prices soar earlier this year, as supplies to the US were squeezed. With the US already working to tackle high levels of inflation, China’s domestic policy is having a heightened impact around the world, an indication of China’s greater clout on the global stage. However, while China’s most recent figures may suggest a positive outlook, a deeper dive into the statistics reveals a different story. In the first half of this year China’s economy grew by 2.5% which may seem impressive by global standards but is significantly below the government’s target of 5.5% annually. Of this 2.5%, exports contributed 0.9%.  

An over reliance on exports for growth could be problematic for China; with 20% of China’s GDP coming from exports, it is possible that it has a mutually dependent relationship with its foreign customers. 34% of Chinese exports go to the EU and US and with expectations of a recession high in those regions, China can expect to see demand for its exports fall and with it, the high growth rates that it has enjoyed for so long. There are suggestions that China’s exceptional export performance may only have been driven by an easing of strict lockdowns, with factories only now being able to fulfil orders after months of being shut down. 

What does the chart show?

 The chart shows expectation of future interest rates in the US for upcoming Federal Open Market Committee (FOMC) meetings up until January 2024. Calculated using data from Fed funds futures, it shows the number of interest rate hikes/cuts that markets are expecting between now and future FOMC meeting dates. It also shows the expected policy rate at those dates. According to the market, the Fed policy rate is expected to continue to rise sharply with at least three more rate hikes by November this year, bringing it above 3% as the Fed looks to tackle the high levels of inflation. The hikes are then expected to continue into 2023 but at a slower rate until a reversal in February. With cooling economic data increasing fears of a recession, the Fed is expected to begin a period of rate cutting until early 2024, bringing the rate down to around 2.7% by 2024

 Why is this important?

 As the 26-27 July FOMC meeting drew to a close, the Fed announced its second consecutive 75 basis point rate hike, as it seeks to tackle the rampant levels of inflation in the US economy. A 9.1% year-on-year Consumer Price Index print in July reinforced that inflation remains a persistent problem for the Fed to tackle. Economic data released throughout July also pointed towards a slowdown in growth. The US technically entered a recession, as Gross Domestic Product fell by 0.9% in the second quarter, with house sales and jobless claims also indicating that a downturn is imminent. Despite cooling economic data and further rate hikes to come, equity markets have rallied in the US returning 9.3% over July, with growth stocks leading the way. This rally has been driven by economic data and inflation expectations leading markets to believe that the monetary tightening cycle may not be as strong as previously feared. However, this expectation relies on inflation being brought under control in the coming months. Past data suggests that long-term predictions of the Fed rate are rarely accurate, and Fed Chairman Powell has declared future changes will be determined entirely by the data, offering no forward guidance. With such high uncertainty, it is difficult to determine whether a corner has been turned or whether this is simply just another bear market rally. However, with careful diversification, blending risk assets with defensive and low-correlated assets, we believe it is important to ride out the volatility and stay invested.

What does the chart show? 

The chart shows consumer confidence indices for the US, UK, and the Eurozone area since 2005. Consumer confidence is a measure of how confident consumers feel about the state of the economy and the stability of their income. A fall in consumer confidence provides an indication of a future fall in consumer spending, as households face uncertainty and may therefore look to save more of their income, leading to a cooling of economic activity. Consumer confidence was showing signs of rolling over even before Covid-19 struck, but fiscal and monetary stimuli during the pandemic boosted confidence levels, following their sharp drop. UK consumer confidence has fallen below the levels seen during the Covid pandemic and currently sits around levels last seen during the Global Financial Crisis in 2009, while the Eurozone’s sits at levels not seen since the earliest days of the pandemic. US consumers are also growing more pessimistic, with confidence levels having fallen for the third consecutive month following the strong recovery seen post-pandemic.   

Why is this important? 

Record levels of inflation, dramatically tightening monetary policy, and high food and energy prices have now forced many households to reconsider their economic situations, as growing fears of an imminent recession take hold. Demand for labour remains high, and households are sitting on excess savings, suggesting that consumers are not in a completely unfavourable position. With inflation high and consumer confidence low, consumers are already starting to cut back heavily on discretionary spending. Bleak expectations among households may become self-fulfilling, as consumption is drastically cut and economic activity cools. With careful diversification, blending risk assets with defensive and non-correlated assets, we believe it is important to ride out the volatility and stay invested, to participate fully in longer-term opportunities emerging. 

What does the chart show?

Inflation remains one of the key concerns in markets. The chart shows the US, Turkey, and Sri Lanka Consumer Price Index (CPI) year-on-year over the last five years. June inflation numbers once again surprised on the upside in the US at 9.1% year-on-year (vs 8.8% expected), its highest reading since November 1981. The surge in inflation is due to a mixture of supply disruptions, elevated global demand, as well as surging energy prices following Russia’s invasion of Ukraine. The inflationary surge has not been limited to the US – Europe and the UK are also experiencing red-hot inflation figures (with UK inflation hitting 40-year highs this week). However, Turkey and Sri Lanka are battling far worse economic situations, facing whopping 78.6% and 54.6% year-on-year rises in prices respectively. While external macroeconomic factors are partly to blame, internal politics and poor policy-making have exacerbated matters and resulted not just in economic catastrophe, but also in the collapse of the Sri Lankan government. 

Why is this important? 

Global inflation has led to many central banks tightening monetary policy and raising key interest rates. Turkey is facing similar surges in consumer prices, reaching levels not seen for 24 years. The central bank was forced by president Recep Tayyip Erdoğan to slash interest rates towards the end of last year, exacerbating existing inflationary pressures. Deteriorating confidence in the country has also worsened the inflation backdrop with the currency plunging versus the dollar; consequently pushing up import costs and intensifying price growth. Of course, the US is a much larger, diverse and more established economy than Turkey and Sri Lanka combined, so we should be careful about drawing any parallels. However, policymakers should take note of just how quickly inflation can get out of control if it is not contained quickly, or if central bank independence is jeopardised.