Five Letter Words

By Elwin de Groot, Head of Macro Strategy at Rabobank

Five Letter Words

Overnight developments in the US indicated that a bill on the debt ceiling suspension and cap on federal spending –which the nonpartisan CBO yesterday estimated would cut deficits by USD 1.5 trillion over 10 years– is yet another step closer to Congressional passage, as the influential House Rules Committee voted 7-6 in favor. The bill is now on its way to the full House of Representatives. Passage today is seen as crucial to getting this bill through the Senate before the June 5 deadline. Any further delays could still spark fresh market volatility, but an actuary take on this suggests that the more progress this bill makes, the higher its survival rate is.

So for now it appears that the market’s focus will shift further towards the weakness in global manufacturing, a notion that was given fresh impetus by weak Chinese data overnight. The manufacturing index fell to 48.8 from 49.2, instead of rising slightly as per the consensus estimate. The services sector index managed to stay well in positive territory, but nevertheless fell more than expected. That raises fears that the Chinese economy has already lost most of its post-reopening momentum. The Chinese data corroborate our overall impression that the direction of travel for the global economy is negative, even though a robust services sector is limiting the pace of deterioration.

With the huge upside surprise in UK inflation for May still fresh in memory, European inflation data –from Belgium and Spain– reminded markets of the uncertainty that surrounds these data. Belgian headline inflation fell 0.4pp to 5.2% in May, as it benefited from a sharp fall in gas and electricity prices. But, just like the UK CPI, core inflation made a surprise rebound to 8.7% y/y from 8.3% in April. Looking into the details, the timing of Easter (relatively early in April) and Ascension Day and Whit Monday (both late in May) could have played into this by temporarily pushing up prices in the holiday and recreation sector. Indeed, plane tickets, holiday rooms and holiday villages and camping sites combined were good for some 0.25% of additional price increases in that month. This may reverse come June. That said, higher price increases for private rents, car repairs and eating out in restaurants and at French fries stands, a Belgian (and Dutch!) favorite, will likely not reverse. And so this Belgian core inflation number still leaves a bit of a greasy (or sticky?) aftertaste.

The better news came from Spain, where both headline and core inflation for May fell more sharply than expected. Harmonized inflation dropped 1.1 percentage points to 2.9%, so a “two” is back before the decimal point. Core inflation also declined by a reasonable 0.5pp to 6.1%, although that is obviously still “three” times the ECB’s target! Still, it was sufficient –together with slipping European economic confidence (driven by weaker industry and trade), the weakest Dallas Fed Manufacturing index since May 2020 and a sharp drop in oil prices ($3/bbl for Brent)– to leave 10y yields some 9bp lower for German government issues, and 13bp for Italian. Their Spanish counterparts did perform a tad less, but were still down 11bp, thus showing little impact from the announcement by Spanish Prime Minister Sánchez to call snap elections on 23 July instead of December this year.

As our Spain economist, Maartje Wijffelaars, notes, that decision might just as well be an attempt to limit his party’s losses in the national parliament, and his best shot at continuing to lead the country. Sánchez evidently hopes that time will be (too) short for the PP, his main opponent, to engage with right-wing party VOX in many of the regions to form a stable center-right block. Plus, the short notice would limit the chances for new or fringe parties to splinter the votes on the left, which could hurt Sánchez’ PSOE. And even if it turns out to be the end for PSOE, there currently is no real reason to expect a better or worse performance under other logical government combinations. The European Commission has recently approved the pay-out of the third tranche of the RRF funds, which suggests Spain is making adequate progress on reforms and investment.

Back to the topic of sticky inflation, RBA’s Lowe may well need a stronger mouthwash to rinse that sticky feeling as well, as Australian data showed a sharper-than-expected rise in April inflation. The headline CPI came in at 6.8%, higher than the 6.4% expected and up from 6.3% the month before. Although the inflation rate was impacted by the end of government fuel subsidy, the consensus clearly underestimated this. In a speech before senators at Parliament House (and just before the release of these data), Mr. Lowe said that the RBA is “very much in a data dependent mode” and that further interest rate hikes would depend on unit labor costs, the global economic outlook, inflation expectations and consumer spending. Well, that seems rather evident; and housing was not mentioned even though it was one of the biggest contributors to inflation in April. But, again, it shows that central banks around the world are still struggling with the question whether (underlying) inflation has truly turned the corner and whether or not they have done enough to bring it back into line at some point in the future. Our RBA watcher, Ben Picton, believes Mr. Lowe hasn’t finished the job.