The desk believes that the market's shift from inflation concerns to recession fears will create volatility in FX markets, particularly impacting risk-sensitive currencies. Per the full note from Standard Chartered, the growing downside risks to growth are now a focal point for investors, suggesting a potential recalibration of positions. This transition is underscored by recent economic indicators showing a slowdown in growth forecasts. With our consensus target for EUR/USD at 1.075, the market is poised for significant movements as traders navigate these conflicting narratives.
What the desk is arguing
The desk posits that the evolving narrative from inflationary pressures to recessionary concerns will lead to increased volatility in FX markets. Per the full note from Standard Chartered, this shift is prompting investors to reassess their strategies amidst conflicting economic signals. The implications for risk-sensitive currencies could be profound as traders grapple with the potential for a downturn in economic activity.
Supporting this view, recent data has shown a notable decline in growth forecasts, with analysts now anticipating a more pronounced risk of recession. This shift in sentiment is likely to influence currency valuations, particularly for those currencies closely tied to economic performance. As inflationary pressures ease, the focus will increasingly shift to how central banks respond to these changing dynamics.
Where it sits in our coverage
Our consensus target for EUR/USD stands at 1.075, with a range between 1.04 and 1.12. Specific firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns with jpmorgan, which sees a stronger euro in the near term, while bofa presents a more cautious outlook, suggesting divergence in expectations among market participants. The desk's call is positioned at the upper bound of the consensus range, indicating a more optimistic view on the euro's resilience against recession fears.
How other firms see it
Several firms, including jpmorgan and citi, are aligned with our view, anticipating a potential strengthening of the euro as recession fears mount. Conversely, bofa and deutsche express skepticism, forecasting a weaker euro amid persistent economic challenges.
In this context, the EUR/USD trajectory will be closely tied to the ECB's policy decisions and the evolving economic landscape. Traders should also monitor the USD/JPY pair for potential spillover effects, as shifts in risk sentiment could drive movements across these correlated currencies.
What the calendar says
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Hello, and welcome to this special podcast from Standard Chartered. I'm Manisha Tank. It is the second half of the year and the global outlook for 2022 and 2023 is out.
And I always have this great opportunity to have a bit of a deep dive with our team at Standard Chartered. So we have with me Eric Robertson and also Sarah Heughan. So here are a couple of the things that we've been talking about and seeing in the headlines.
A global recession very much on the cards. And we've heard this from the highest voices in global economics. And also consumers are really struggling with spiraling higher prices.
Inflation is causing some issues on the back burner as well. Concerns about debt levels. There's plenty to talk about.
Eric, what are the big questions that are coming up? I think one of the best ways to start the discussion is this incredibly toxic environment where for the first part of the year, we were all worried about upside risk to inflation. But all of a sudden, that focus has evolved to include not just downside risk to growth, but a growing chorus of recession forecasts.
With a recession forecast, you'd think that inflation would be heading down, but it still seems to be making new highs in a number of places. So we have the worst of all worlds in the sense that we have still elevated inflation, downside growth risks, concerns about corporate profitability, concerns about consumer spending. And that's raising all kinds of really uncomfortable questions for not only policymakers, but I think for investors and corporate clients as well.
So the really big question coming out of client discussions at the moment is how do we navigate these two almost conflicting narratives between inflation and recession? We're going to talk a little bit more about how this is being digested in the markets. Sarah, I wanted to get your take as well on these different scenarios that are playing out and what that means in terms of the severity of the picture that we're facing right now.
We've got quite a few signs that the US economy is slowing and our concern is that we will see a recession later this year. Manufacturing surveys have turned down. Consumer confidence is very weak.
CEO confidence is also down in the dumps. We've seen a tightening of financing conditions and a bear market in stocks. So all of these factors together ring quite loud alarm bells about the risks of a downturn later this year.
On the positive side, households have managed to accumulate savings during the pandemic. We still see excess savings households able to draw on those funds to finance ever spiralling costs. But ultimately, high inflation is leading to demand destruction and that's likely to mean recession sooner or later.
What's interesting about that is there have been questions over demand destruction. What is the importance of this? It's supremely important because households are really facing higher costs, particularly from food and energy prices.
But also we have some lingering impact from the pandemic. Prices of goods are still elevated and that's reflecting the supply disruptions that we saw last year and early this year. Altogether, even though employment is looking pretty strong, employment rates are back down to their pre-pandemic lows, it's becoming a tougher environment for households.
So this is broadly what we mean about demand destruction and for businesses, it's not a very comfortable environment. If households are having to spend more on travel, on fuel, on their day-to-day food bills, then there's less essentially to spend on other stuff. And it starts to become a problem for businesses and for business earnings.
Eric, I was reading through some headlines earlier, and everyone's now talking about variants of COVID. Some of those concerns have not gone away. People are not turning up to work.
There's a labour shortage. There are all sorts of problems going on. I'm wondering about the sentiment out there right now.
Demand destruction is especially problematic from a sentiment point of view, because if you remember, it wasn't very long ago where we said demand will be extremely robust, even with higher prices, because there was this pent-up demand of the last two years. People in lockdowns, people accumulating savings, and all of a sudden, as the world started to open up again, they could travel, they could spend. And if things were 10, 20 percent more expensive, well, so be it.
People had accumulated this pent-up demand. All of a sudden, we've shifted dramatically in the other direction. Demand destruction is happening because, frankly, the prices are not up just 10 or 20 percent.
They're up 30, 40, 80 percent in some cases, and that's just causing quite a bit of sticker shock for people. The renewed COVID concerns, even with many countries' desire to learn to live with COVID, is in some ways exacerbating that, because it just means that everything we try to do, whether it's travel or business activities, is just harder, and there's a frictional cost of doing business and of even pursuing leisure activities that has gone way up, and I think that's exerting some downward pressure on a number of different markets. Take copper.
Copper is down 35 percent from the highs in the first quarter of the year. That is a function of demand destruction, that's a function of broken supply chains, and it's a function of renewed recession risks. So lots of these factors are coming to play at the same time.
They certainly are. You have this concern that markets haven't quite priced all of this in. So I'm curious to understand where that concern is coming from, but also what this means for the outlook.
It would be tempting to say that with, again, copper down 35 percent from the highs, U.S. equities and global equity markets down anywhere from 20 to 30 percent year to date, it would be very tempting to say, oh, the recession is priced. We argue that it's not because there are a number of factors that are just starting to kick in that I think auger pretty poorly for financial markets. Number one, dollar strength.
Now, the dollar has been strengthening for a while, but it's now up 10 percent year to date. In June, it was up 10 percent over the previous 12 months. Historically, that is a very negative warning sign for corporate revenues, and we have only just started to see an erosion in corporate earnings.
Now, you could say, oh, but markets are down. They're down because P.E. ratios have come down. We think there's another leg lower because of the downward revision to earnings.
The other factor that is not fully priced in yet is the fact that central bank balance sheets, which have been expanding for a long time now, are set to go into reverse, and balance sheet contraction means a contraction in liquidity, and that's going to prove quite difficult for both developed and emerging financial markets. Sarah, you've talked about the Fed aggressively front-loading, a much more aggressive policy tightening. How far does that go?
We're expecting another outsized rate hike at the upcoming meeting, and we think that the Fed will indeed continue to raise rates aggressively this year, but we think that by November, there are going to be some clear signs that the economy is turning down and that the worst of the inflation is over. So, at that point, we'll see the Fed halting, and that's around about a 3% Fed funds rate, which is lower than the market is expecting for the peak in the current cycle. Now, the markets have Fed tightening further, but then expect rates to fall through 2023 into 2024.
So, markets are very much shivering that they expect the Fed to make a big policy mistake. Our view is that they'll stop before they get to that mistake. Sarah, just continuing on that theme, though, something that is on the outlook is also the incredible uncertainty, of course, about geopolitical events.
There's still a situation in Ukraine. This hasn't gone away, and we know that some of the price pressure was coming from there. So, central banks are faced with a situation where this isn't just a case of monetary policy.
There is much more to this. The big challenge, of course, is for Europe. High gas prices in Europe and the risk of a weaponization of gas from Russia, leading ultimately to the prospect of rationing of gas later this year.
These factors are highly likely to drive the Euro area economy into recession. We expect that there's going to be a downturn anyway, as the ECB tightens policy and given these very challenging cost pressures. But if we do see gas cut off later this year, then that's clearly going to be a very big hit to businesses and to consumers.
Eric, I want to bounce back to this dollar strength story. Who wins? Who loses?
Historically, one might say that dollar strength or currency weakness for the other economies would offer a big benefit to trade-dependent or export-dependent economies. What we're finding in the current environment is that dollar strength is bad for everybody. It tightens financial conditions for the U.S. economy, specifically through the U.S. corporate channel.
But for foreign economies, a weaker currency is exacerbating the inflationary shock that they're experiencing, because it means imported inflation is that much worse with a weak currency, especially in a world where food and energy prices are so elevated, even with the recent correction. What we're finding is that the inflationary impact of a weaker currency is actually offsetting the benefits that might accrue to trade from a weaker currency. So I think there's a real concern with the dollar at multi-decade highs now that it's going to provide a major headwind to the global economy, not just to the U.S. economy.
It's incredible, actually, Sarah, to think of the euro being a parity with the dollar. From a symbolic point of view, it seems pretty important. It's increasingly going to be a point of concern for policymakers when you have the euro so weak, and that adds to inflation pressures.
There are also real worries about the political outlook across Europe, with uncertainty over Italy. Italy will face an election, and we're seeing a widening of spreads between Italian bonds and German bunds. Now, still not at crisis levels, or indeed nowhere near crisis levels, but the ECB has to respond with an anti-fragmentation measure, something that is going to be a backstop to financial markets across Europe to ensure that as they raise rates, that's not going to result in another euro area crisis.
I promised that we would move on to slightly more positive stories, but what's interesting is we've just seen a growth number from China, which perhaps wasn't what we expected. China has been on quite a stimulatory run. Eric, what are the consequences of that?
Growth in the second quarter looked really quite bleak, obviously a function of lockdowns related to the Covid surge and the zero Covid policy. China is starting to open the stimulus floodgates, mostly on the fiscal side. They've announced all sorts of infrastructure and investment spending measures that will be designed to lift economic momentum in the second half of the year, and the advantage of fiscal policy is that it can be directed quite specifically and quite quickly to those areas of the economy that need it most.
On the more challenging side, we believe that the consumer outlook in China still remains reasonably challenged. Unemployment rates for those aged 18 to 24 or 26 years old are nearly 20%. Consumer sentiment has been damaged by the weakness in the real estate market.
Our concern is that even with the fiscal stimulus and the liquidity that's being provided from a monetary point of view, that it may create a bit of an upside momentum, but it may not be enough momentum to take China back towards its growth targets of 5.5%. In fact, we think China's growth for the year will have a final result around 4%. We need to see a recovery in economic momentum in China that is strong enough to have some spillover effects for the rest of the region, but to get that we may need to see China's borders with the rest of the region open up as well.
Sarah, if you had to categorise winners and losers, which ones would you say would be most at risk and which ones would you say would be most likely to benefit from the outlook? If we look at countries that are trading quite heavily with the US and Europe, then we do see risks ahead. So, for example, in Asia, Korea's leading index points to rising concerns.
In Taiwan, there's some indication that demand for electronic goods is slowing. By contrast, other countries like Malaysia, Philippines, Thailand benefiting from a recovery in tourism and stronger exports to China. Equally, in the Middle East, we've seen oil exporting economies doing very well out of the increase in oil output and in higher prices.
Now, that may start to change over the course of the next 12 months, but still they've managed to build up some pretty strong reserves as a result of high commodity prices. By contrast, like Pakistan, Egypt, Turkey face growing headwinds from slower demand in the US and Europe and they've also to deal with depreciating currencies and slower inflows, indeed outflows from their economies. So, big challenges for some countries and big opportunities for others.
Eric, one of the big opportunities is, of course, the transition to net zero. We're going to talk about that as an economic opportunity. We're going to talk about the fact that this actually could be the saving grace for this outlook to some extent.
What's your view? One of the things we've spent quite a bit of time thinking about over the last couple of years, especially with regards to the commodity space, is that this transition that you described is ultimately meant to take us to a world that is more sustainable, whether it's from an energy point of view or a food point of view. The reality, though, is that that will require a significant upfront investment in a lot of basic commodities and materials.
The possible scenario for people to ponder is that as we get through the darkest part of the recession forecast and outlook over the next 12 months, the forward outlook starts to think about where will a capex cycle come from. And you have a number of economies that will spend quite aggressively in pursuit of that transition strategy. Now, the complication is that a number of economies that had committed to this over the last couple of years may find that they don't have the financial resources to do so now after spending two years fighting COVID and another year sort of getting through this commodity shock.
And so fiscal space for a number of economies may be quite depleted. But that offers an opportunity for the private sector to invest, to co-invest. These public private partnerships that are becoming more commonplace is going to present real opportunities for people to invest in that capex cycle.
And if our recession forecast for US and Europe is correct, you could be looking at getting into that capex cycle at very low or very cheap and attractive levels. So that's quite a positive scenario. Sarah, how important is that acceleration of that transition for the US economy?
There are going to be some economies that are leading the way. You have a big drive from the EU to move ahead on the net zero challenge with substantial resources being directed. Those EU funds will lead the way, will set the tone for the private sector as well.
The regulatory environment is also going to be changing and that's going to be a significant feature. So individual economies can't afford to be left behind on that. I expect that that's going to apply to the US as well as to many other countries.
Sarah, in your best case scenario, where are we by the end of 2022? In the best case scenario, we're seeing clear signs of a slowdown in inflation. And yet we have managed to avoid an economic downturn.
If confidence can turn around, and that may well come from a lower inflation environment, then households will continue to spend and will have the wherewithal to spend. Best case scenario, of course, would see conflicts resolved. So it's always good to look on the bright side.
That is still a realistic possibility. As always, it's a pleasure to speak to you both, Eric Robertson, Global Head of Research and Chief Strategist, and Sarah Heughan, Head of Research for Europe and Americas. I hope you both enjoyed the conversation and I hope the audience did too.
I'm very thankful to everyone, everywhere for listening. I'm Manisha Tank. Goodbye.