China announced a sweeping lockdown and testing regime in Shanghai to combat Covid. The move is likely to have significant ramifications for Chinese growth and could spill over as another headwind for global activity as investors continue to mull the fall out from the Ukraine war. Crude oil is down nearly 4% at writing in response, with copper also displaying some softness in overnight trade (while iron ore is trading marginally higher). Yields will remain the focus for markets this week, with another strong NFP report Friday liable to cement expectations that the Fed will up the pace of tightening at the May and perhaps beyond. We remain broadly bullish on the outlook for the USD.
The GPB was rescued from losses into the mid-1.31s by a solid beat in PMIs data published today, while still holding to a 0.1/2% decline on the session and a failure to recoup the 1.32 handle. The country’s composite PMI came in at 59.7 vs 57.5 expected and 59.9 previously, with the services sector index—climbing 0.5 points compared to a 2.5 points drop in manufacturing—behind the bulk of the resilience in the headline reading. However, prices charged inflation jumped to a record high (since 1999), which combined with the war in Ukraine, saw business optimism fall to a 17- month low. Gilts are again outperforming Bunds and USTs—although UK yields are up today versus yesterday’s decline. UK debt led yesterday owing to a significantly lower than expected debt issuance plan released by the DMO alongside Sunak’s budget update (the GBP ignored the news). The Chancellor announced a £9bn support plan for households that included tax cuts, a lower fuel duty, and increased grants, but the OBR estimates that Brits will still face a 2.2% decline in disposable incomes over the 2022 fiscal year. The OBR’s projections also provided some insight into how the BoE’s forecasts will change in its May MPR. The estimates show that a bank rate of 1.61% by end-22 that peaks at 1.9% in Q3-23 (as implied by market pricing ahead of the forecast exercise) is accompanied by inflation falling to 1.2% in Q1-24. Market pricing was depressed in the sampling period owing to Ukraine war risks, which means that similar BoE forecasts due out in May that incorporate a 2% Bank Rate by year-end (and almost 2.25% in Feb 2023, latest OIS pricing) would likely show a larger undershooting of inflation. Markets should take the OBR’s forecasts (and their implication for the May MPR) as a sign that the BoE will not move as quickly as hike bets imply and will likely have to push back against hawkish expectations soon. We believe the GBP faces downside risk to 1.28 on a re-pricing of BoE expectations while the Fed moves ahead and meets market pricing.
