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Global Macro – EM EMEA prospects

Notwithstanding the confluence of challenges, the EM EMEA region is operating slightly above potential from a growth perspective, consistent with robust performance of EMs in aggregate. Inflation has continued to fall and surprise to the downside across most of EM EMEA (bar Turkey, Russia and South Africa). Given this generalised easing in inflation, some EM EMEA central banks have cautiously begun to lower benchmark rates and we see lower policy rates in H2 2024. In a global environment marked by an unfavourable growth-inflation mix, higher for longer rates, low liquidity and a strong US dollar, we continue to recommend macro stabilisation markets (Poland and Turkey) and structural growth narratives (GCC region) within the EM EMEA region. We also believe that investors are increasingly becoming comfortable with two frontier markets owing to idiosyncratic developments – Egypt (external financing relief and credit upgrades) and Nigeria (return to orthodox macro policies).

US Fixed Income: Economic activity is mixed (but decelerating), data should be adjusted for inflation

Macro View: Given the growing underlying cracks in the jobs data, the burden that higher rates are having on the margin (for lower-income households, small businesses, CRE-sector lending, bank balance-sheets, corporates in the high yield sector and even the federal government), it’s only a matter of time before US macro conditions worsen. 

On the inflation front, the May CPI and PPI prints were lower than the April readings for both the headline and core readings. The supercore measure in the CPI report also saw one of its sharpest declines in May as well. The one area that remains stubbornly elevated is owners-equivalent rent (OER) and shelter costs (which are lagging the declines in actual market-based rent inflation trends). In our view, an eventual catch-up towards lower inflation readings from OER should pull CPI lower. Commodity prices also continue to display major fluctuations, but are more in line with potential lower inflation readings ahead. We find the big move lower in lumber prices, for example, a bit troubling as it implies that US housing data will weaken further (which again should then feed back into lower housing-related prices over time too). 

On the growth front, there continue to be mixed signals from a whole host of measures related to economic activity. The May NFP report saw a solid 272k jobs created, as per the establishment report; however, nearly 90% of that is a function of the birth-death model. Meanwhile, the household survey, which is used to calculate the unemployment rate (U/R), saw a decline of 408k jobs for the same month. The U/R rate also rose to 4% in the last reading (breaking a trend of sub 4% readings that had been in place since early 2022). Lastly, we continue to find evidence that the uptick in the regional manufacturing PMIs in Q1 were a one-off improvement (linked to inventory rebuilding) and will not be reoccurring. Overall, US economic activity remains mixed (but decelerating).

Market view: In terms of our Fed call, post the hawkish leaning SEP update at the June FOMC meeting in which forecasters only showed one cut pencilled in for 2024, along with chair Powell’s more hawkish than usual tone at the presser, resulted in us pushing back our call for the Fed’s first cut to September (from July). We were one of the last holdouts in terms of the first Fed cut because we have been of the view that they should start normalization sooner rather than having to cut aggressively in the future if conditions worsen. We assume data will continue to soften and although risk assets are in a melt-up phase (perhaps the last big move), they can just as easily roll-over at any moment. The Jackson hole speech could tee-up a September cut as well.

FX Outlook

The US dollar has strengthened modestly since the last release of the Global Markets Monthly (22^nd May) with the US jobs report on 7^th June and then the FOMC meeting on 12^th June the key developments that helped provide the US dollar with upside impetus. Nonetheless, US-specific drivers faded and front-end yields have declined but this failed to weaken the dollar with external developments aiding the dollar. This most obvious example was the surprise decision by French President Macron to call snap parliamentary elections. The outcome of these elections and what happens to the OAT/Bund spread will be important for the direction of the key EUR/USD rate in July and as we have argued downside risks and the potential for a break below the key 1.0500-level have increased. Still, this is happening at the same time as evidence of potentially weaker US employment conditions is increasing. We expect the Fed to commence cutting rates in September and that will be the key development that we believe will take the US dollar to lower levels through to year-end.

USD/JPY - Bearish Bias - 153.00-164.00

EUR/USD - Bearish Bias- 1.0400-1.1000

USD/CNY - Bearish Bias- 7.2000–7.2800

 

KEY RISK FACTORS IN THE MONTH AHEAD

• The main upside risk for USD/JPY would be yet another stronger than expected US jobs report and/or other key data in July, like CPI. That would see US yields jump higher again and no doubt encourage renewed USD/JPY buying at levels over 160.00. A benign outcome in the France elections could also encourage renewed EUR/JPY buying that prompts overall yen weakness to extend further. The flip-side is the obvious risk to the downside. An outright majority for RN in the parliamentary elections could lift risk aversion, hit EUR/JPY significantly and trigger a general outperformance of the yen.  
• The main upside risks for EUR/USD are: i) if the US economy and/or labour weakens sharply bringing forward Fed rate cut expectations and encouraging a weaker USD, ii) if there is a third consecutive month of slower US inflation in Q2 it would reinforce confidence that the pick-up in Q1 was temporary and encourage the Fed to cut rates sooner, and iii) if the right and left-wing parties underperform expectations at the upcoming French elections and/or they continue to tone down their policy agenda after the elections helping to ease market fears.   
• For USD/CNY, we see both upside and downside risks for the CNY. Further upside can be additional real estate policy support, solid plans for reforms, and concrete plans for cyclical support. Downside risks could come from lack of positive signals from the Third Plenary Sessions, further frictions between United States and China e.g. US restricting US enterprises investing in China and hiking tariff rates on imports from China.