• Our central case is that the Federal Reserve has the ability to ring-fence financial stability concerns
• Higher funding costs for small and regional banks are likely to tighten US financial conditions via the credit channel, where lending standards were already being tightened due to monetary policy
• While we expect growth to slow over Q2, we expect no immediate recession given momentum in consumption, a strong labour market and little disruption to lending from large US banks
• We expect the growth impact from the excess credit tightening (i.e. that above monetary policy) to be relatively small (c.0.5p)with a two quarter lag. Coupled with previous tightening, we expect a mild recession in Q4
• A moderation in shelter inflation should slow US inflation, but strength in wider service inflation and employment should push the Fed to do a final hike in May
• Euro area disinflation should continue but we expect core inflation to remain elevated, leaving the ECB hiking through the quarter, reaching a terminal of 3.5%. We also see one more rate hike from the BoE, but expect the BoC and RBA on pause from here
• We expect Japan to exit yield curve control in June and change its rate guidance to a neutral (from dovish) stance
• We expect China to grow strongly over the quarter, driven by are covery in consumption and a fading drag from the property sector. However we still expect inflation to remain low and monetary policy to retain a small easing bias
FX Views
• Credit tightening in the US accelerates the Fed tightening cycle by hurting growth and reminding the Fed there are lags to monetary policy
• While we disagree with near term cuts from the Fed priced by markets, our view that inflation and growth should moderate continues to pose downside risks to US 2-year yields
• This leaves our view of dollar weakness unchanged as a receding terms of trade shock and China reopening improve the growth outlook for Europe and Asia, giving rise to interest rate convergence (US vs Europe and Japan)
• We see dollar weakness being broad based. Crucially, this reflects our near-term positive view on equity risk as fears of banking stress prove overdone, inflation in the US softens and China fully reopens. The latter should also support commodity prices, despite slower growth in developed markets
• We most like EUR (+) and GBP (+) given resilient banking sectors, improved growth outlooks and hiking central banks
• We like safe-havens JPY (+) and CHF (+) mainly through the lens of risk-reward. A dovish PBOC suggests AUD (+) is the better expression of China reopening than CNH (0) given a backdrop where equities and commodities are supported and there are hawkish risks around the RBA. We see CAD (0) as the most likely to underperform given little domestic driver
• We continue to like BRL (+) and MXN (+) for their attractive carry, underpinned by relatively hawkish central banks
• We keep our views tactical, given the uncertainty around the size of the credit tightening and our longer-term caution around recessionary risk, which would likely prompt a defensive rotation
This piece of content contains the views and opinions of our Global Economic Research and Strategy Team as of 5th Oct 2023 and does not necessarily represent the views and opinions of Millennium Global or any of its Portfolio Managers.
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