Is inflation risk increasing

11 March 2024
isinflationriskincreasing

AT A GLANCE

  • Last week confirmed a resilient growth and a friendlier change in tone from central bankers
  • The key risk to the soft-landing narrative could be switching from recession to inflation
  • We’ll get a clearer picture with February CPI reports this week. Ramadan Kareem!

Last week was eventful with regards to the big picture. First, a series of economic data, especially leading indicators, confirmed that the global economy not only remains resilient, but also turns more balanced, with a broadening of growth engines. Seeing some rebound in Europe, Japan avoiding a technical recession, China setting ambitious growth targets for 2024 provides a healthy regional diversification. With regards to the US, the previous sectoral imbalance between services and manufacturing is narrowing, with the latter outpacing the former when it comes to PMIs. Finally but crucially, the tone of central banks became more friendly. While they remain cautious and data dependent, hearing the Fed’s chairman saying that he is “not far” from the level of confidence needed to cut rates is clearly good news, especially as the rise in US unemployment rate and the moderation in wage increases, from Friday’s monthly jobs report, provide some additional comfort. As a result, the implied number of rate cuts in 2024 from futures markets increased last week, from 3 to 4 (it had fallen from 8 at the beginning of the year). Bond markets appreciated, and stock markets didn’t mind.

While we’re happy with the market returns and their impact on our asset allocation profiles, vigilance is still needed. There are two variables in the soft-landing scenario: growth is fine, but market focus could switch to the trajectory of inflation. We are not overly concerned but continue to expect volatility ahead, including on currencies as monetary policies could start to diverge in the coming quarters. We will know more this week with the US CPI and PPI reports, and also watch US and China’s retail sales and industrial production. We will also hold our monthly tactical asset allocation meeting. We wish you and your families Ramadan Kareem.

Is inflation risk increasing

Cross-asset Update

Looking back to the past week we maintain the impression of unrivalled US exceptionalism, while at the same time we saw a revival of animal spirits in other markets, and China setting bold economic targets for the year that renewed hopes for sizeable stimulus. Smaller companies outperformed alongside developed ex-US equities, and cyclical stocks made a new high for the year against the more defensive ones. Overall, investors must be gaining conviction that the economy will continue to do well, even as the disinflationary process remains on track.

All eyes were on the US labor market, and Powell’s testimony. The former told the usual story of US economic strength, the latter confirmed that rates have peaked. We can then infer that good economic momentum should continue, a further nod to the softlanding scenario. And the missing link of a manufacturing recovery is slowly coming into place as well, as the S&P Global US Manufacturing Index has been in expansion territory for the last two months, with the all-important gauge of new orders to inventories in the ISM release hovering close to the highs of the year. On the inflation front the week brought good news as well. The prices paid sub-index of the services PMI survey was way below expectations, pointing to still easing price pressures in the United States. Good news came also from Europe and China. Christine Lagarde and numerous ECB officials confirmed that the central bank is moving closer to rate cuts, with June being the most likely month to start the easing process. In China the ambitious economic targets for the year communicated at the NPC leave the impression that this time some sizeable stimulus is unavoidable. Unless it is accepted that animal spirits can be depressed by the failure to deliver, setting in motion a negative feedback loop from the disappointment of economic agents to the economy.

Overall, it seems that there is scope for the broadening of the rally, with rotations to more pro-cyclical themes supported by the strength of the economy. Both the Fed and the ECB suggested that policy direction is now towards easing, with gold rallying well in advance of the public announcements. As inflation concerns are for now in the rear-view mirror, rate cuts seem all but assured in investor minds, so animal spirits live on. Markets are now overbought and overdue for a pause. Either a pullback will occur, or the rate of ascent will be slower. Which is which is, as usual, impossible to tell.

Is inflation risk increasing

Is inflation risk increasing

Is inflation risk increasing

Fixed Income Update

Finally, a good week for bonds as central banks changed their hawkish tune, and US unemployment numbers reached a two-year high of 3.9%. The belly of the curve outperformed as the 5 and 10 years moved down by 10 bps while the front-end stayed anchored and the longend moved down by 7 bps. Last week, during the twoday congressional testimony, Chairman Powell hinted that the Fed members were comfortable with the trajectory of inflation and not worried about the surprise in January inflation. A significant portion of his comments were identical to his prepared remarks at the January FOMC press conference, indicating the strength of the January labor market and inflation data hadn't materially changed his view on the economy. He suggested the central bank is getting close to the confidence it needs to lower interest rates. Markets ran with the theme that the Fed is close to rate cuts, with OIS swaps suggesting a full rate in the June FOMC meeting. Tomorrow's CPI numbers will be closely watched as economists anticipate the Headline CPI to accelerate to 0.4% on a monthly basis, even though Core CPI is expected to increase at a slower pace of 0.3%.

Last Thursday, the ECB stayed on hold as expected. Still, changes in the forecasts were more dovish than expected, mainly because officials cut their 2024 inflation and GDP forecasts to 2.3% and 0.6%, respectively. This spurred expectations that the ECB may be the first big central banks to cut rates. Governor Christine Lagarde mentioned that the ECB is now "more confident" in disinflation and "there are signs that growth in wages is starting to moderate." Similar to the Fed, markets are expecting a rate cut in June.

Egypt hiked its policy rates massively by 6% to 27.25% on Wednesday. The government also abandoned the previous exchange rate regime. As a result, the Egyptian Pound devalued to trade above 50. This removed the final hurdle for the IMF deal, resulting in the latter agreeing to more than double the support package to $8bn yesterday. CBE also lifted limits on FX overseas credit card use, giving rise to the hope that the strict controls that had been in place since October last year would be gradually removed. The UAE's pledge to invest $35bn in Egypt through ADQ catalysed these positive developments. This investment dwarfs Egypt's current annual deficit of $4.3bn as of Sep 2023. Even though inflation will spike in response to the major currency devaluation, stable currency in the months ahead will ensure inflation subsides thereafter. Taken together, these should help domestic bond yields to head lower over the coming year.

We recommend investors take advantage of this by entering the Egyptian Pound carry trade, where they borrow in USD and invest in local currency 1-year Egyptian T-Bills unhedged. Despite withholding tax, this should generate double-digit returns for investors, given the extent of the devaluation and the high nominal yields expected to be on offer. Hard currency Egyptian bonds have rallied significantly and are not offering a similar high-return opportunity anymore.

Is inflation risk increasing

Is inflation risk increasing

Equity Update: Our outlook for 2024

Elections, hopes of disinflationary trends, central banks turning dovish and big tech continue driving market moves in 2024. A positive week for most markets, except the US, which saw tech lose some of its mojo, with chip stocks having a bad Friday. A soft-landing narrative in data flow has been received well by markets with renewed conviction on cuts by DM central banks starting June. Encouraging signs that the Fed's efforts to tame inflation, partly through slower wage growth. US equities will likely be supported if we get confirmation that the disinflationary trend is in place.

The S&P 500 ended the week at 5124 (-0.3% last week) and the Nasdaq at 16085 (-1.2% last week) retreating from record highs with a sell-off in semiconductor shares. Both indexes are still up over 7% YTD and the rebound in earnings growth remains in favour of range bound trading. The SOXX Index while falling 4% on Friday, closed the week up and is +18% YTD with Nvidia +77% YTD. News of a stock split for Nvidia is unconfirmed. A small correction for big tech would not be surprising, after the huge rally but probably leaving most with positive YTD gains. About $4.4bn was pulled from tech funds in the week through March 6, according to BofA strategists. Small-cap stocks held up relatively well. The Russell 2000 closed near its two-year high +0.3% for the week, its fourth weekly gain in the past five. Japan and European equities rose 2.5% in USD last week, with both the yen and the Euro strengthening.

UAE and KSA companies have raised dividends: notably the banks in the UAE and more recently Saudi Aramco in the KSA. Total payments this year expected at about $124.3 bn — up 66% since 2021. Oil prices trending above $75/bbl for Brent are positive for Saudi Aramco cash flow.

Our DM overweight region Japan has outperformed in both local currency and dollar returns. However, as the Yen continues to strengthen, exporters are starting to have concerns. A drop of at least 2% in the Topix triggers BOJ buying of ETFs, supporting the market. The focus in Japan remains on shareholder returns and earnings yield: dividend and buybacks is around 5% for Japanese equities, we stay overweight.

Emerging market equities are more in the green now +1.5% YTD with India and the Dubai Index leading. China equities have been in an uptrend since early Feb but still negative YTD and last week saw negative returns. Mainland China indices have performed better than the MSCI China and Hang Seng Index. A-shares look better positioned with liquidity and valuation support, given the A-share investor base and the government's stabilization effort. The National People’s Congress has concluded, largely seen as underwhelming. We remain neutral China equities.

Novo Nordisk best seller drug Wegovy got expanded US approval on reducing the risk for heart attacks and strokes. This could widen use and insurer coverage of the popular anti-obesity medication. However Eli Lilly, also a leader in obesity therapeutics saw Alzheimer’s disease drug Donanemab face further delays in gaining US approval. We recommend adding healthcare stocks to portfolios as strong growth beneficiaries and a hedge against a concentrated tech portfolio.

Is inflation risk increasing

Is inflation risk increasing

Is inflation risk increasing

Written by:

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), a public joint stock company incorporated in Dubai, United Arab Emirates (UAE) and licensed to provide various financial services including promotion, financial consultation, securities portfolio management, managing investments of investment funds, etc. Emirates NBD is regulated supervised and controlled by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”), having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

This publication is prepared without regard to the individual financial circumstances and objectives of persons who receive it. Data/information provided in this publication are intended solely for illustrative purposes for the general information or its recipients, irrespective of their customer classification as an Ordinary Investor or Professional Investor under the SCA Regulations.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accept any responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they may not be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor.

Where this publication provides any information about Shariah compliant products, the Bank will not have engaged a Shariah board (or similar body) to determine independently whether or not such products are compliant with Shariah principles. The Bank accepts no liability with respect to the fairness, correctness, accuracy, reasonableness or completeness of any such determination or guidance by any Shariah board that has certified or otherwise approved such products as Shariah compliant. Nothing contained in this publication shall be construed as a recommendation by the Bank to invest in such product. In deciding whether to invest in Shariah compliant products, you should satisfy yourself that investing in such products will not contravene Shariah principles. You should consult your own Shariah advisors as to whether investing in such products is compliant or not with Shariah principles.

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investor may lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.