Eurozone inflation soars in October

• Elevated Eurozone inflation data last week has led to increased bets that the ECB will be forced to tighten policy sooner than signposted, even as ECB President Christine Lagarde tried to push back against the narrative at the previous day’s ECB meeting. Price growth in the bloc soared to 4.1% y/y in October as energy price rises hit home, up from 3.4% the previous month and exceeding consensus projections of 3.7%. Even with the energy costs stripped out, core inflation was at 2.1%, the highest in nearly 20 years. The day before the inflation release, Lagarde had said that the ECB’s analysis did not support the market view that the ECB would hike rates in December 2022, reiterating that the current high levels of inflation would moderate next year. However, the subsequent inflation release brought those expectations forward even sooner to October 2022. Similar dynamics are playing out in the UK, where inflation expectations have been soaring ahead of this week’s Bank of England meeting, but MPC member Silvana Tenreyo has told the press that a hike before year-end is unlikely as the bank expects price growth to moderate.
• US GDP growth was just 2.0% q/q (annualised) in the third quarter, missing projections for 2.6%, and slower than the (also disappointing) 6.7% in Q2. The recovery from the pandemic has been constrained by the supply chain issues that have weighed on growth around the world, with the automotives sector in particular struggling with shortages of semiconductors.
• China’s manufacturing PMI survey remained in contractionary territory in October, coming in at 49.2, down from 49.6 in September and missing projections of 49.7. This is the second month in a row that the index has come in under the neutral 50.0 level, with supply chain issues and power shortages at the root of the slowdown. The non-manufacturing index was at 52.4, helping boost the composite index to a positive 50.8. By contrast the Caixin manufacturing survey released this morning rose from the neutral 50.0 in September to 50.6 for the October reading.
• The Central Bank of Egypt kept its benchmark overnight deposit rate unchanged at 8.25% at the close of last week, the eighth consecutive meeting at which rates have been held pat. The decision was widely expected despite rising inflation, as real interest rates remain strongly positive and price growth is expected to moderate in the coming months. The bank’s communiqué noted that real GDP growth in Q2 2021 was 7.7% y/y, compared to 2.9% in the preceding quarter.
• The G20 summit took place in Rome, where all 20 country heads signed off on the global tax initiative that looks to implement a worldwide base tax rate for large multinational firms. Another key development at the event was a new deal between the US and the EU regarding tariffs on steel and aluminium. Meanwhile, many leaders took the opportunity to urge greater progress on environmental issues.
• Saudi Arabia’s budget recorded a surplus of SAR 6.7bn (USD 1.8bn) in Q3 2021, the first quarterly budget surplus since Q1 2019.  Oil revenues jumped almost 60% y/y although non-oil revenue declined -22.4% y/y.  Total budget revenue rose 13% y/y while expenditure declined -7.7% y/y.  The data supports our view that the government has prioritized deficit reduction this year as oil income has surprised on the upside relative to forecasts at the start of 2021. We estimate the full year budget deficit will shrink to -1.1% of GDP this year from -11.2% in 2020.
• Separately, data from SAMA show money supply growth accelerated to 8.4% y/y in September (7.9% in August), while private sector credit growth picked up to 15.2% y/y (15.1% in August). Bank deposit growth has been driven by government entities’ deposits since the summer. Net foreign assets at SAMA grew USD 11bn in September to USD 448bn, the highest since December 2020. Consumer spending slowed slightly in September but is still up over 9% y/y in the first three quarters of this year.  

Today’s Economic Data and Events

18:00 US ISM manufacturing survey, October. Forecast: 60.5

Fixed Income

• The UST curve extended its flattening trend last week in anticipation of the upcoming FOMC meeting where we expect the Federal Reserve to announce it will begin tapering asset purchases. Disappointing Q3 GDP data from the US also didn’t help sentiment and helped to sink the front-end of the curve. Yields on the 2yr UST rose more than 4bps last week to settle just below 0.5% while the 10yr UST yield fell 8bps to 1.5521%. That brought the 2s10s curve to just 105bps at the end of the week, its flattest level since August and down from nearly 130bps at the start of October.
• We expect the Fed will outline its plan to start tapering asset purchases at the FOMC this week with a monthly drawdown of purchases of USTs and MBS likely to bring all buying to a halt at some point in Q3 2022 provided economic data doesn’t veer substantially off course. They may also highlight some of the elevated inflation pressures affecting the US economy although the tools at their disposal aren’t well calibrated to deal with supply chain distortions.
• The Bank of England will also set policy this week (Nov 4) and we think that they will hold for now, even as policymakers there have been more outspoken about the threat of inflation. The UK curve also flattened with 2yr gilt yields up 4bps to 0.7% while the 10yr fell 11bps to 1.032%.
• Emerging market bonds recorded a mixed performance last week with Turkish 10yr government bonds managed a modest rally with yields slipping 4bps to 19.345%. South African bonds, however, fell sharply with yields gaining 27bps to 10.178%. Indian yields rose 2bps to 6.388%.
• Moody’s affirmed their ratings on eight UAE banks and revised the outlook to stable from negative for all them. The banks covered are Abu Dhabi Commercial Bank, Abu Dhabi Islamic Bank, Commercial Bank of Dubai, Dubai Islamic Bank, HSBC Bank Middle East, MashreqBank, National Bank of Fujairah and National Bank of Ras al Khaimah.
• Apart from the Fed and Bank of England, the RBA also sets policy this week as does Norges Bank which recently raised rates by 25bps at its September meeting.

FX

• The dollar gained sharply on Friday, more than recovering losses earlier in the week. The broad DXY index added 0.5% over the course of the week, closing out at 94.123 as markets adjust to expected tightening of Fed policy. EURUSD fell more than 1% at the end of the week, settling at 1.1558 and down 0.7% for the week as a whole while USDJPY rose 0.4% to 113.95.
• GBPUSD also fell on Friday, down 0.8% on the day to 1.3682 and down 0.5% on the week. The Bank of England sets policy this week and could raise rates—not our central forecast—just as the UK is enduring slow growth and suffering from supply chain issues.
• Among the commodity currencies, CAD failed to get much positive traction from the hawkish BoC meeting during the week and USDCAD rose 0.18% to 1.2388. Both AUD and NZD rose over the week to 0.7518 and 0.7171 respectively as markets judge the central banks there more likely to respond quickly to inflation pressures.

Equities

• Equity markets were mixed last week, with strong performances in Europe and the US matched by weaker performances in Asia. Japan’s Nikkei was an outlier, gaining 0.3% w/w, but the Hang Seng (-2.9%), the Shanghai Composite (-1.0%) and the Sensex (-2.5%) all ended the week lower.
• In the US the NASDAQ was the biggest gainer, adding 2.7% w/w, while the S&P 500 closed 1.3% higher and the Dow Jones lagged with a 0.4% gain. In Europe, the FTSE 100 added 0.5%, the DAX 0.9% and the CAC 1.4%.

Commodities

• Oil prices recorded their first weekly decline since early September for Brent markets and late August for WTI. That said, with drops of just 1.3% in Brent to USD 84.38/b and 0.2% for WTI to USD 83.57/b the declines were marginal. Weak data out of the US and China over the last few days, along with pending tightening of monetary policy from the US and perhaps UK could, on the margins at least, weigh on the outlook for demand in the coming months.
• More crucial for oil markets this week will be the next OPEC+ meeting where the producers’ bloc will set policy for December. Public statements from officials within OPEC+ suggests they will proceed with adding 400k b/d per month, slower than many importing nations have wanted, and helping to keep oil markets tight and prices holding onto their elevated levels.

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