Supply Chain Disruption Likely in Malaysia If Truck Driver Strike Worsens

The Bank of England is navigating a narrow path between thrusting the UK economy into full-scale recession through further monetary tightening and easing off from its task of bringing down the inflation rate to 2%. Huw Pill, the Bank’s chief economist and executive director for monetary analysis and research, told an OMFIF audience on 16 October that the Bank might still have work to do to reduce inflation further. He left open how the Bank may still be thrown off course by the disturbed international environment.

The latest figures from the Office of National Statistics show that headline inflation in the UK is falling, with the consumer price index at 6.7% in September, holding steady from August. The most significant decrease in the monthly change was due to declining prices in the food and beverages category, while petrol and diesel contributed the most to the upward pressure on the inflation rate.

For now, markets are pricing in a high likelihood that the BoE will hold rates steady at 5.2% at the next meeting in November. But Pill insisted that ‘the [Bank of England’s] mandate is not to have declining inflation. It is to achieve the 2% target on a lasting and sustainable basis,’ adding that ‘We probably have work some to do in order to get back to 2%.’

The UK’s inflation remains highest among G7 economies. Over the long term, there are signs of more ‘persistent components of inflation’, which include ‘that part of inflation which will still be there at the 18-month to two-year horizon’.

According to Pill, the persistent components of inflation are associated with domestic pricing decisions, domestic cost dynamics and domestic wage-setting behaviour in the UK. The labour market still appears tight. ‘Official average weekly earnings data… looks very high, and has tended, if anything, to surprise to the upside.’

The underlying reason for wage growth will determine whether a monetary response would be needed. ‘Stronger wage growth driven by the right reasons – like stronger productivity growth – would certainly be something I’d welcome,’ Pill explained. But a wage-price spiral in response to the cost of living crisis ‘would be a cause for greater concern’.

More generally, labour market data are proving more difficult to interpret than in previous cycles. ‘Whether the tightness in the labour market is better represented by the unemployment gap, the level of vacancies or the ratio of vacancies to unemployment or the number of quits in the economy’ is unclear. ‘These are all indications which historically actually move quite nicely together,’ reflected Pill. ‘They have not moved as closely together over recent times, and that reflects some of the magnitude of big supply shocks.’ For the BoE, he admitted that these converging metrics has been a ‘big challenge for us to try and understand’.

The length and depth of the current tightening cycle will also be influenced by the timing and effectiveness of monetary policy transmission. Pill was asked several times about the stated view of Swati Dhingra – the most consistently dovish of the Bank’s nine-person monetary policy committee – that only 20 to 25% of the monetary tightening since the Bank started raising rates at end-2021 had so far worked through. In answer, Pill indicated that the amount of effective tightening was appreciably higher than that range, although he did not give a more precise estimate.

Mortgage rates are still the primary metric of the impact of rate hikes on the wider economy, but this mechanism has become more complex than in other tightening cycles. Pill commented that, ‘on the one hand, the structure of the mortgage market has changed considerably. Mortgage rates are refinanced every two or five years. That is different from the world of 30 years ago where mortgage rates were very closely tied to the bank rate itself’. This complicates policy transmission, potentially causing lags.

At the same time, he pointed out that the BoE ‘are able to monitor [monetary policy transmission] much more closely, because we now have data on every mortgage’. More robust supervisory capabilities allow for a more granular understanding of the housing market and, therefore, a more finely calibrated policy response.

Monetary policy implementation has become more difficult in face of multiple exogenous shocks. Pill noted that as the supply side has become more uncertain, the ability to work out where excess demand is in the economy has become more complex.

To add, risk factors are compounding. On the frequency of macroeconomic shocks, Pill reflected, ‘The key question for us is, are these shocks at the tail end of a distribution, which will go back… to a normal bell shape? Or should we be thinking about a very different distribution of shocks?’ This question will be especially pertinent if violence in the Middle East escalates.

Spearheading this effort is Ben Bernanke, who is conducting a review of the BoE’s forecasting during times of major uncertainty. The review started this summer and is due to conclude next year, with the results set to be released in spring 2024. ‘I would hope that we would be able to see something and act on it relatively promptly, in the spring,’ stated Pill.

A reassessment of risk scenarios would also need to be effectively communicated to the public. At present, the Bank’s communications still revolve around a single fan chart. They may need to reconsider this, as we are clearly in a world of bigger shocks.

As we write this today there is no water or electricity in Gaza. Soon there will be no food or medicine either. An unprecedented humanitarian catastrophe is unfolding before our eyes. Every hour we receive more desperate calls for help from people across the Gaza Strip.

Over 2 million Palestinians live in Gaza. More than half are children. All are now subjected to the siege, further tightening a 16-year-old blockade. Israel’s order to all Palestinians living in northern Gaza and Gaza City to move to the southern part of the strip triggered an exodus towards an already massively overcrowded area. And there is nowhere else to go.

Gaza is one of the most densely populated places in the world. The 365 sq km area is bordered on one side by the sea, the other side is controlled and fenced by Israeli security forces. The remaining border with Egypt is closed for people fleeing the war and in between the area is bombarded - there is no safe place.

The death toll is rising and hospitals are flooded with wounded and injured people in need of immediate and at times complicated surgery. Thirteen United Nations Relief and Works Agency (UNRWA) staff have been killed; UN premises have been damaged, including medical facilities; and currently more than 500,000 people are sheltering in UNRWA schools.

What is taking place in Gaza may amount to collective punishment for the atrocities carried out by Hamas on Oct 7.

Last week’s attack on Israelis was horrendous - devastating images and testimonies continue to come out. Killing and maiming civilians and taking them hostage is a flagrant violation of international humanitarian law and may constitute war crimes. Hamas must be held legally accountable for its actions.

But the answer to killing civilians cannot be to kill more civilians. Imposing a total siege and bombarding civilian infrastructure in a densely populated area is not the solution. It will not bring peace and security to Israelis and to the region. This war comes from deep underlying grievances on both sides and only intense and genuine negotiations can make the changes that are required.

The laws of international armed conflict set minimum standards for the conduct of all parties with one consistent and permanent goal: To reduce the human suffering caused by conflict. The Fourth Geneva Convention relates specifically to the protection of civilians during times of war. This is in recognition that civilians and those taking no active part in the conflict - men, women and children - bear no responsibility for the conduct of parties to the conflict and must not be targeted in retaliation.

The Geneva Conventions prohibit the targeting of civilians and civilian infrastructure and attacks that do not discriminate between legitimate military targets and civilians. Attacks must not result in disproportionate loss of civilian life and damage to civilian objects even where there is a military objective, and collective punishment is prohibited. Violation of these fundamental obligations can constitute international crimes including war crimes and crimes against humanity.

People in Gaza feel desperate - and abandoned by the international community. They are asking "Where is the UN and where is UNRWA?" The UN is in Gaza. UNRWA alone has more than 13,000 staff working round the clock with very limited resources that may run out at any time.

Even if the siege is lifted we do not have the resources to meet the immense need for water, food, medicines and psychological help. The UN cannot supply the civilian population even with basic life-saving materials unless it receives significant support. We call on all member states of the UN to express solidarity for UNRWA during this time.

But above all, we must act - we all have a duty, both moral and in law, to protect civilian populations. International law and respect for human life is never more important than in moments of despair, anger and polarisation.

A humanitarian suspension of hostilities must take place without delay to spare the loss of more lives. Israel must stop the siege, stop indiscriminate bombardment of civilians and facilitate a humanitarian corridor. Hamas must release all hostages unharmed immediately.

Humanity must prevail. Otherwise, there will be tragic consequences for the years to come, in Gaza, the region and beyond.

Stocks markets fell deeper into the red on Thursday after widespread losses yesterday on the back of the tense mood in the Middle East that has fanned the rally in crude oil, which in turn is pushing up soaring bond yields even higher.

President Biden's unscheduled visit to Israel on Wednesday was marred by the bombing of a hospital in Gaza that prompted Arab leaders to cancel a planned summit with the US President. But although a ceasefire looks even further off than it did prior to this week's developments, there was some relief that Biden is stepping up efforts to get aid into the Gaza strip as well as urging Israel to proceed cautiously amid preparations for a possible ground offensive.

The ongoing risk of an escalation of the conflict that could draw in other regional powers such as oil-rich Iran driving oil futures up more than 3% at one point. A much bigger-than-expected drop in weekly US crude inventories added to the upside pressure.

Both WTI and Brent crude futures later erased some of those gains to close around 1.8% higher but gold maintained a sturdier uptrend. The precious metal has jumped more than 6% since the outbreak of violence in Israel on October 7 and it is trading higher today to test the $1,950/oz level.

Demand for safe havens failed to put a cap on bond yields although yesterday's auction for 20-year Treasuries did attract plenty of buyers. Nevertheless, concerns not just about the rise in oil prices but also about the recent run of solid economic indicators out of the United States has added fuel to the rally in Treasury yields.

The yield on 10-year Treasury notes reached a fresh 16-year high of 4.97% today, while the 30-year yield breached the 5.0% threshold for the second time in two weeks.

Fed officials have been questioning the need for additional rate hikes lately, arguing that the tighter financial conditions stemming from higher yields has done some of the work for them. But after the hattrick of data beats from the nonfarm payrolls, CPI and retail sales reports, investors have begun to price in a higher probability of one final 25-bps rate hike.

Speaking in London yesterday, Fed Governor Christopher Waller signalled a pause in November, saying he wants to “wait, watch and see”, but he did not rule out “more action” at a later point if needed. All eyes today, though, will be on the Fed Chair as Powell will be speaking at the Economic Club of New York (16:00 GMT) before the blackout period begins at the weekend.

Stock markets took fright from the relentless upward march in bond yields, with all three of Wall Street's leading indices closing lower on Wednesday. Even if the Fed decides against raising rates further, the ‘higher for longer' reality is slowly sinking in for investors, with rate cut expectations pared back sharply this week.

After starting the week on a positive note following a strong set of bank earnings on Friday, stocks took a dive yesterday as rising borrowing costs took the steam out of the latest bounce, while the Israel-Gaza conflict further muddied the outlook.

Morgan Stanley was a major drag as the stock plunged 6.8% after the bank reported a 9% fall in its Q3 earnings. Tesla's results also disappointed and its stock looks set to extend yesterday's 4.8% drop, which came even before the earnings were announced.

However, Netflix could spread some joy today as its stock surged by more than 10% in after-hours trading when it reported impressive revenue and subscriber numbers.

The US dollar was mostly steady on Thursday, failing to significantly capitalize on the spike in Treasury yields as well as the flight to safety. The dollar index remains below its October 3 peak, suggesting that FX markets are adhering to the shift in Fed rhetoric differently to bond markets.

The pound is trading at a two-week low as yesterday's hotter-than-expected UK CPI data did little to alter much rate hike bets for the Bank of England. The Australian dollar, meanwhile, is one of the worst performers today, weighed by a smaller-than-forecast increase in Australian employment in September, which slightly dented expectations of the RBA raising rates again.

The latest inflation figures will be a huge disappointment to Rishi Sunak, as they will be to millions of households across the UK who long for the cost-of-living crisis to end.

Economists expected a small fall in September from August's 6.7% inflation rate, but instead it remained stubbornly unchanged.

The prime minister promised in January to halve last year's 10.7% rate by the end of 2023 and that looks in jeopardy.

To steal the words of the former Manchester United manager Sir Alex Ferguson when he acknowledged how the closing stages of the men's 2003 Premier League title race was a close-run thing, it's squeaky bum time inside No 10.

For those advisers who told Sunak the target was a surefire winner, giving Jeremy Hunt some room for manoeuvre in his autumn statement on 22 November and more importantly in his pre-election budget next year, life is going to be uncomfortable.

There was better news from a fall in food prices, which dipped month on month by 0.1%, compared with a rise of 1.1% between the same two months a year ago.

This brought the annual rate of food inflation down to 12.2% from a recent high of 19.2%.

Next month, there is likely to be a one percentage point drop in the consumer prices index (CPI) from gas and electricity prices, which have stabilised since the dramatic increases seen last year.

James Smith, an economist at the Resolution Foundation thinktank, said the effect of the energy price cap increase last year dropping out of the CPI comparisons would be even larger, sending inflation below 5% and handing Downing Street a comfortable victory.

Suren Thiru, economics director at the accountancy body ICAEW, was not so sure, saying only that the fall in energy costs would only bring inflation below 6%.

The wild card is the cost of petrol, which offset the drop in food last month and could continue to climb if the crisis in the Middle East escalates.

Thiru said September's "sticky inflation" meant a Bank of England meeting to set interest rates in November was "on a knife-edge".

Another interest rate rise risked "needlessly suffocating economic activity and deepening the financial distress for people and businesses", he said, but it was possible if policymakers decided to take a hard line.

Smith said he was concerned that ministers would choose to ignore September's inflation figure when setting benefits next year.

The September figure is supposed to be the basis for the increase in benefits the next April, allowing 9 million recipients a chance to plan their household incomes.

He said a decision to limit the increase, as it has done seven times since 2010, would mean many low- and middle-income families across Britain "will pay a heavy price".

He added families who receive benefits would experience a fall in incomes of £460 on average from a freeze, "while many low-income families with kids face much higher income losses, rising to £1,200 for a low-income couple with two children".

It is an indication of the difficulties faced by all households when inflation remains elevated, eating into disposable incomes.

A rise in interest rates from 5.25% will bring extra pain running into thousands of pounds a year for mortgage payers, posing another headache for the prime minister as he tries to navigate his way to sunnier economic uplands.

Bank Indonesia (BI) surprised market participants with a rate hike today in a bid to help shore up the IDR.

The central bank believes that the global economy is set to face increasing headwinds with uncertainty on the uptick, and indicated that a "stronger policy response" was needed given the heightened uncertainty in the financial markets. It now predicts that global growth should settle around 2.9% year-on-year in 2023 and 2.8% next year with the US Federal Reserve now set to keep rates higher for longer. Given the backdrop, BI sees capital outflow persisting for the rest of the year.

With the Rupiah down 1.77% for the month, BI had little choice but to whip out additional policy support for the currency.

With growth momentum apparently intact, BI felt it had the space to carry out "a preemptive and forward-looking move" to ensure that inflation remains manageable. It indicated that it would maintain "loose macroprudential policies" to provide some support after today's rate hike. Bank lending remains robust (8.9% YoY as of September) with BI expecting this pace to accelerate to 9-11% YoY by next year.

Today's move will likely provide some relief for the IDR by taking the still-narrow interest rate differential to 50bp over the Fed. We believe that Bank Indonesia will remain open to further tightening should the Fed carry out a hike of its own, with IDR stability set to remain a likely decision point for the rest of the year.

A quiet day on the data front, with only US Philadelphia manufacturing index and weekly jobless claims due for release.

Fed chair Powell will discuss economic outlook at the Economic Club of New York this evening at 18:00 CET. With the FOMC's blackout period starting on Saturday, this will be a key opportunity to guide the market ahead of the November meeting. That said, market is already well priced for the Fed to remain on hold while keeping the door open for a final hike in December or January.

Other Fed speakers on the wires today include Jefferson, Goolsbee, Barr and Bostic.

People's Bank of China will likely maintain Loan Prime Rates unchanged overnight in line with the unchanged medium-term lending facility rate earlier this week.

Israel-Gaza conflict: Joe Biden visited Israel yesterday, with one key focus area being ensuring humanitarian aid to civilians in Gaza. Biden also discussed the issue in a phone call with Egyptian president Abdel Fattah El-Sisi who agreed to allow around 20 trucks of daily aid into Gaza via the Rafah crossing, which is the sole non-Israeli entry and exit point to the area. Earlier this week, Biden administration was reported to be preparing a USD100bn supplemental funding package to cover aid to both Israel and Ukraine as well as several domestic US issues. However, while such package would likely pass the democratic-controlled Senate, the House of Representatives is still unable to vote on any new bills, as it has not been able to elect a new speaker after ousting Kevin McCarthy. The current nominee Jim Jordan was rejected for the second time in a vote last night. And even if a new speaker was found, it remains unclear if especially the more hardliner republicans (who Jordan represents) would support a package linking Israel support to additional funding for Ukraine, even if the former has fairly broad-based support across Congress.

Fedspeak: Overall, market sentiment remained sour yesterday, with equity markets falling, 10y UST yield soon approaching 5% and broad USD strengthening. The most recent Fed speakers, including Waller and Harker yesterday, have communicated that the Fed has room to continue monitoring effects of past tightening by extending the September pause into November. But markets still price in an additional 14bp of tightening for the December and January meetings. NY Fed's Williams commented that he is ‘not convinced yet neutral rate has risen' which would suggest that monetary policy is already clearly restrictive. One area where the impact is very visible is the housing market, as the MBS index of new mortgage applications for purchase has declined to the lowest level since 1995 amid 30y mortgage rate hitting 8% yesterday. That said, most of the September hard macro data still managed to surprise to the upside, which we discussed yesterday in our latest US Labour Market Monitor, 18 October.

Equities: Risk-off resurfaced on Wednesday. S&P -1.3%, Stoxx 600 -1.1% and small cap Russell 2000 a full -2.1% lower, taking the indices lower for the week. The negative trigger was yields, rising to a new year-high. It was not a growth-to-value rotation though but a cyclical sell-off. Materials (also driven by weak Chinese housing data) sold off with Boliden and SSAB down 4-6%. Note that the sell-off came despite unchanged industrial metal prices. Industrials and consumer discretionary also underperforming, losing -2-3%. US futures are continuing lower this morning.

FI: The upward surprise in UK inflation data drove GILT yields markedly higher yesterday with contagion effects on global bond markets. The 10Y GILT yield ended the day 15bp higher, while the 10Y Bund yield rose 4bp. Curves bear steepened across markets. BTP-Bund spreads widened ahead of S&P reviewing Italy on Friday, probably partly reflecting some uncertainty on how the Meloni government's proposal of fiscal easing worth an estimated EUR24bn next year could affect the credit assessment.

FX: Higher US yields, eroding risk appetite and rebalancing needs hit smaller currencies such the SEK and NOK. EUR/SEK and EUR/NOK escaped the recent range on the topside while both USD/SEK and USD/NOK moved back above 11.00. EUR/USD was relatively stable yet with a slight favour of the USD leg. USD/JPY still has its eyes on 150. EUR/GBP fell after the high inflation numbers, GBP gains proved transitory. CHF benefits from its safe-haven status as EUR/CHF pushes toward ATLs.

Credit: Yesterday, the negative sentiment in equity markets drove credit spreads wider, iTraxx Xover was 10.2bp wider at 455.2bp while iTraxx Main was 2.2bp wider at 85.7bp. That said, the primary credit market was active but the amount of deal activity was observed as limited. In the Nordic space, H&M printed a EUR500m 8Y green bond at MS+150bs. The books were above EUR3bn and IPT was at MS+165-170bp, these conditions indicate healthy investor appetite for selected names despite an increase in volatility, higher rates and lower indices.