GLOBAL CREDIT BULLETS | Monday, 25th October 2021

UK – stagflation getting real
September UK inflation remained elevated, with the print delivering a 0.3% monthly increase and 3.1% annual change. RPI, the retail measure, surprised even more strongly on the upside, and is now running just below 5% annual. PPI inflation now hovers just shy of 12%. The composition shows a broad based increased, with goods markets driving the move, pointing to UK specific Brexit effects adding to global inflation pressures. The 2% BOE target seems now very far, despite some signs of slowdown coming from product and labor market shortages, and some concerns induced by the still high number of daily infections in the country. UK is thus turning into a good example of what the recent stagflation fears may look like. The BOE has been worried about inflation since late summer, with MPC members discussing potential inflation peaks much higher than current levels (4-5%), and more hawkish communication in recent weeks. The November meeting is now live, and hikes by 1Q22 (and before QE tapering) are almost a given. High inflation expectations are now feeding to markets too, as opposed to other countries. 1y RPI breakevens now hover around 6.4%, almost 2% above spot. Strong inflation, rapid hikes, and GBP risks around Brexit means UK rates are among the few curves in G10 set to underperform US rates in the upcoming global monetary tightening.

Turkey – when it rains, it pours
A flurry of bad news is hitting Turkey and Turkish assets. Last week, the central bank surprised markets by a larger than expected cut. Interest rates have now been cut 300bp to 16% since summer, despite the global tightening trend and domestic inflation running at 20%. On top of that, over the weekend President Erdogan publicly threatened to make 10 ambassadors of Western countries “persona non grata” in Turkey, in a major public blow to the West. Diplomatic tensions are especially concerning ahead of the Biden-Erdogan meeting scheduled for next weekend, where key matters on US-Turkey relations need to be discussed. Overall, Erdogan seems to be in fully electoral campaign mode, which usually carries a boost to credit-friendly policies and hawkish foreign policy. The campaign though may be happening at a tough time for Turkey macro: the Fed is just about to start a long tightening cycle which could arguably push the dollar stronger, and external / reserves buffers of the country remain weak (gross reserves are $90bn, less than 5 months of imports), despite some uptick over summer. The Turkish lira depreciated 24% in 2021, but locals are still holding tight, with retail dollar deposits not increasing massively this year (almost flat at $235bn). A stronger push in the next few weeks risks triggering local selling, with potentially grim consequences for the balance of payment and the currency.

ECB – PEPP guidance in the spotlight
At the ECB meeting on Thursday, forward guidance will be on the spotlight. After the Fed has telegraphed the start of tapering in November, the ECB will need to communicate more clearly about its intention regarding purchase programs. This means more clarity on when purchases may start tapering more meaningfully, and also what kind of program will prevail once PEPP expires in March. APP is the natural framework as it’s already in place, but has technical problems (capital key and IG rating requirement mean the current composition of PEPP can’t be replicated within the APP framework). The ECB will also need to deal with a discussion of hikes, as the BOE is likely to go ahead and markets are pricing some chances of a 2022 hike in Europe. In our view, Lagarde will push back on this in such a way to firm up hikes expectations back to 2023. Overall, the meeting should not carry big news, but communication will need to be clearer. The current rates market pricing is inconsistent with the inflation path forecast by the central bank, suggesting guidance needs to be improved. We continue to think the ECB will tighten slower than the Fed and UK, with an announcement of gradual tapering, no substantial changes to the PEPP composition and no hikes before 2023.