Global Monthly - Key views
The post-pandemic recovery is being hampered by the Russia-Ukraine conflict. The services recovery is being weighed by the inflation hit to real incomes, while industry faces new headwinds from higher commodity prices and a delay to the normalisation – in some cases intensification – of supply bottlenecks. Lockdowns in China add to these risks. We still expect inflation to decline this year, but the jump in commodity prices and supply disruptions is delaying this. We expect energy prices to remain high over the next few years, with sanctions on Russia triggering a lasting trade realignment. Upside inflation risks mean the Fed is likely to raise rates much more quickly than we thought previously. The ECB has signalled its intent to normalise policy, and we now expect rates to start rising in September. Europe will also continue to feel the global spill-over effects of tighter US monetary policy over the coming year, pushing bond yields higher and ultimately dampening growth.
Macro
Eurozone
Hard economic data for the period after Russia’s invasion in Ukraine still is scarce. However, high frequency data and surveys suggest that there was a considerable negative impact from the jump in energy, food and other commodity prices and the sanctions on Russia. All in all, the eurozone economy is expected to grow only a bit above the trend rate this year, despite a post-COVID rebound in certain part of the services sector. Next year, slower global growth and less accommodative monetary policy in the eurozone should reduce growth to slightly below the trend rate (around 0.3-0.4% qoq). This implies that underlying domestically driven inflationary pressures should remain contained.
Netherlands
Strong growth from 2021 carries over to growth in 22, together with a rebound due to the phasing out of Covid restriction in January we expect the economy to expand by 0.3% in Q1 2022. The war in Ukraine however lowers the growth outlook. Second and third quarter growth will be modest and fourth quarter growth will be flat. We expect the drag on growth stemming from inflation to come fully into force in the second half of 22. For 22 as a whole growth this means growth is expected at 3.1%. We have lowered our forecast for 23 growth from 1.9% to 1.3%.
US
Consumption growth has continued to slow, as real incomes are being squeezed by high inflation and – increasingly – tighter monetary policy. We expect this to continue through 2022. While there is still significant room for the services sector to recover following the easing of the Omicron wave, the pace of recovery is likely to be slower than we thought previously. Inflation continues to be the biggest risk to the outlook, although there are some tentative signs of easing pressures in the labour market. Should the Fed raising rates beyond our current expectation, there is a risk of a more prolonged downturn.
China
Real GDP growth in Q1-22 surprised to the upside (4.8% yoy). Growth was strong in January/February, but slowed sharply in March. This reflects wider lockdowns adding to supply bottlenecks and hitting domestic demand. We had priced pandemic drags into our growth forecasts, but revised our near-term forecast lower again due to the lockdowns. Still, we leave our annual growth forecasts for 2022 at 5.0% so far, remaining 0.5 pp below the official target of 5.5%. We still assume a cautious stepping up of piecemeal, targeted support, although Beijing gives short-term priority to containing Omicron. The yuan’s correction is a reflection of this, combined with policy divergence.
Central Banks & Markets
ECB
The ECB has become more worried about inflation expectations. We have moved forward our expectations for the first rate hike from December to September. We now expect a 25bp move in each September and December (earlier we expected steps of 10bp). After the deposit rate reaches zero at the end of this year, we expect policy rates to subsequently remain on hold for a period. This reflects that we expect economic growth likely to be sub-trend during 2023. Also, headline inflation will likely fall sharply early in 2023, which should also bring down inflation expectations. Wage growth will not be a threat to the ECB’s inflation goal, especially against the background of weak economic activity.
Fed
Given persistently elevated inflation in the US, and upside risks to the outlook, we expect the Fed to begin hiking rates in 50bp steps in May and June. Thereafter, we expect 25bp hikes until the Fed reaches our estimate of the terminal rate of 2.5-2.75% in early 2023. Thereafter, we expect the Fed to pause, assuming inflation is moving back towards its 2% target. In May, we expect the Fed to announce the unwind its balance sheet, initially at a gradual pace, but eventually for this to run at $100bn per month. There is a risk that the Fed reduces the balance sheet at an even faster pace, via outright Treasury sales, potentially using it as a tool in its fight against inflation.
Bond yields
Both in the US and the Eurozone markets are well advanced with pricing in an aggressive rate hike cycle by the Fed and the ECB. We judge that markets run ahead of itself and we expect repricing of central bank hikes downwards in both the US and the Eurozone. This would in turn result in lower Euro rates as well as US rates. Indeed, we expect the 10y US treasury yield to drop from around 2.9% to 2.7% during the course of this year.
FX/EURUSD
EUR/USD declined towards 1.08. This was on the back of widening yield spreads (nominal and real) between the US and Germany, expectations of more aggressive tightening of monetary policy by the Fed and uncertainty surrounding the war in Ukraine. Our views of the Fed are roughly priced in by the market but our view on the ECB is for less aggressive monetary policy tightening than financial markets now expect. If some of the expected rate hikes by the ECB are priced out, the euro will likely decline. Moreover, the outperformance of the US economy compared to the eurozone economy should also have a downward effect on EUR/USD.