GLOBAL CREDIT BULLETS | Monday, 5th December 2022

China – time to re-think outlook
In the last few weeks, China’s re-opening has been challenged by a massive surge in reported cases.

The government started to relax its zero-Covid policy in early October by loosening restrictions and increasing the autonomy of local provinces in terms of measures.

Consequently, new Covid cases spiked, reaching new highs of 40k daily cases vs 30k in April, and pushing authorities to re-tighten again quickly. The positive is that the government is now more focused on consumption restrictions than it was in April, and in order to avoid supply disruptions is unlikely to stop factory production,.

Moreover on 30^th November, China’s Vice-Premier Sum Chunlan declared Omicron has become less pathogenic, so we see most of the affected regions lifting lockdowns despite continuing high case numbers. Authorities are also planning a new mandatory vaccine campaign, which will bring the over 80s vaccination rate to 90% by 23^rd January, up from the current rate of 66%.

We expect China progress towards re-opening to be slow and bumpy. New cases will reduce labour supply and the growth boost will arrive later than expected (i.e. not before H2 ‘23), hence 2023 growth is estimated ‘only’ at 4%.

Fed – slowing confirmed
Fed president Powell was less hawkish than markets expected at his speech at the Brookings Institution last Wednesday.

Powell signalled a slowing of the pace of interest rate rises at the next Fed meeting in December, confirming our view for a 50bp hike which is now priced by the market with an 80% probability.

The comments finally pointed to some progress in cooling inflation, visible in few leading indicators, as the restrictive monetary policy employed so far has started to be effective. Shelter prices and rentals are lower, whilst data point to better conditions for supply chains.

The statement also suggests a return of the Fed’s double mandate, pointing to a new goal in rebalancing job openings to available workers, for which the current ratio is ~1.7, but without an increasing unemployment rate.

This is in line with our views on policy and inflation. We expect a terminal rate of inflation near to 5% by May 2023 and inflation levels below 6% by Q2 ‘23.

Europe inflation – plateau if not pivot
Eurozone CPI inflation for November surprised on the downside, resulting in the first drop since May 2021.

The index contracted 0.1% during the month, leading to 10% year-on-year versus the 10.4% forecast. Core inflation remained stable at 5% year-on-year, as we expected.

The soft print was broad-based, with all countries except France printing lower-than-expected data. Spain offered the largest surprise, where CPI is now running below 7%, 4% lower than the 11% peak in summer.

The slight reduction in the inflation rate was mostly driven by energy and food, that reversed some of the big increases seen in October and continued to benefit from the strong drop in gas prices seen since September.

Core items are broadly more stable than in the past two months but are not falling just yet. We see October as the likely peak in European inflation, with the headline rate headed towards 7% over the next six months.

Given this latest data, the ECB is now more likely to slow down the pace of interest rate hikes from 0.75% at its last meeting to 0.5% in December, as our estimates indicated in last week’s bullets.

Overall, we think most hawkish members of the Governing Council will continue to push for larger hikes, but those are unlikely to materialize as inflation fails to reach new highs and the Fed slows down its hiking pace. We continue to see the ECB terminal rate ending up close to 3% by mid-2023, not far from where markets are currently pricing.

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Algebris Investments’ Global Credit Team