UK Retail Sales Disappoint in Sign of Lackluster Recovery

Amid escalating tensions in the Middle East, Asian stock markets experienced significant sell-offs on Friday. Reports of Israel launching a retaliatory attack against Iran triggered a wave of investor unease, with Japan's Topix leading losses by shedding 1.9 percent. The index had initially dropped by as much as 3 percent earlier in the trading day. The South Korean won emerged as the region's weakest currency, sliding by as much as 1.4 percent against the dollar to Won 1,392.91.

Gold, a traditional safe-haven asset during times of geopolitical uncertainty, surged by as much as 1.6 percent to $2,417.89 per troy ounce. Similarly, futures for Brent crude, the international oil benchmark, spiked by up to 4.2 percent to $90.75 per barrel, reflecting concerns about potential disruptions to the global oil supply.

In terms of market performance, the Hang Seng index experienced a decline of 1.4 percent, bringing its year-to-date (YTD) performance to a loss of 5.2 percent. The CSI 300, representing China's major stocks, also saw a dip of 0.8 percent, although it maintained a positive YTD return of 3.2 percent. The Topix index's drop of 1.9 percent further extended its negative YTD performance to 11.0 percent. The Kospi index in South Korea mirrored the general trend, decreasing by 1.6 percent, while its YTD performance remained slightly negative at -2.4 percent. The Nifty 50 index in India also experienced a minor decline of 0.6 percent, with a marginal positive YTD return of 0.6 percent.

From a technical standpoint, the heightened tensions in the Middle East can have significant implications for global markets. Geopolitical events often introduce uncertainty, which can lead to increased volatility in financial markets. Investors tend to react swiftly to such events, adjusting their portfolios to mitigate potential risks. In this case, the fear of a broader conflict in the Middle East could impact various sectors, including energy, defense, and transportation.

The spike in oil prices, as reflected by the surge in Brent crude futures, underscores concerns about potential disruptions to the oil supply chain. Any escalation of hostilities in the Middle East could threaten key oil-producing regions and disrupt the flow of crude oil to global markets. This could result in higher energy costs, affecting both consumers and businesses worldwide. Additionally, heightened geopolitical tensions may impact investor sentiment, leading to increased market volatility and a flight to safe-haven assets like gold.

In response to the geopolitical developments, market participants may adopt defensive strategies, such as reducing exposure to equities and increasing allocations to assets perceived as safer havens. Government bonds, particularly those issued by stable economies, could attract increased demand as investors seek refuge from market uncertainty. Similarly, currencies of countries perceived as less exposed to geopolitical risks may strengthen relative to those of nations directly involved in the conflict.

Furthermore, geopolitical tensions can have broader economic implications beyond financial markets. Uncertainty stemming from geopolitical events may weigh on business confidence and investment decisions, potentially dampening economic growth prospects. Businesses may delay capital expenditures or expansion plans until there is greater clarity regarding the geopolitical situation. Moreover, heightened tensions could disrupt global trade flows, leading to supply chain disruptions and higher costs for businesses reliant on international trade.

Despite the immediate market reactions to geopolitical events, it's essential to recognize that investor sentiment can be highly fluid. Market participants may reassess their positions as new information emerges or as geopolitical tensions evolve. Moreover, the impact of geopolitical events on financial markets can vary depending on a range of factors, including the duration and severity of the conflict, diplomatic efforts to de-escalate tensions, and broader macroeconomic conditions.

The recent sell-off in Asian stock markets, driven by escalating tensions in the Middle East, underscores the significant impact that geopolitical events can have on global financial markets. Heightened uncertainty has prompted investors to reassess risk exposures and seek refuge in traditional safe-haven assets. However, it's crucial to monitor developments closely and consider the broader implications for both financial markets and the global economy.

“We work very closely with Governor Perry in order for us to be able to adjust the macro stance to adapt with this new level of pressure,” Finance Minister Sri Mulyani Indrawati said in a Bloomberg Television interview on Thursday, referring to Bank Indonesia's top policymaker.

Indonesia is focused on ensuring that fiscal policy can work as “an effective and credible shock absorber,” she said on the sidelines of the International Monetary Fund and World Bank Group meetings in Washington, DC.

Governor Perry Warjiyo said in a statement from DC that the BI — whose key mandate is to ensure currency stability — will also continue to support the rupiah “with foreign exchange interventions and other necessary measures.” Hours later, the central bank said it's intervening “more boldly” in FX markets.

The comments came as news of Israel's retaliatory strike against Iran roiled markets, pushing currencies including the rupiah to multi-year lows against the dollar on Friday. Indonesia's currency has been among the hardest hit in Asia this month, extending its decline to more than 2.5% in April to a four-year low.

The rupiah dropping beyond the key level of 16,000 versus the greenback — for the first time since 2020, prompted the BI to step up its interventions in the market to stem the fall. It's also adding pressure on the central bank to raise the benchmark rate further on April 24.

“The increasingly all-of-government response is revealing a level of concern that implies a higher risk of a larger, 50bps hike (to 6.5%),” Barclays Plc economist Brian Tan wrote in Friday note.

If the BI holds at 6%, it will likely sound hawkish and hint at the possibility of future hikes, Barclays said. Only six of 21 economists surveyed by Bloomberg so far expect the central bank to hike by 25 basis points on Wednesday, with the rest predicting a hold.

The governor, who surprised markets with a tightening in October amid the rupiah's rout, earlier this week said that the central bank is always in the market. In the statement dated Friday, he said the BI will manage foreign flows in a market-friendly manner, underscoring the importance of stabilizing exchange rate for the nation's resilience.

Southeast Asia's biggest economy on Thursday told its state-owned enterprises to refrain from making large dollar purchases for its import or debt servicing requirements to avoid adding pressure on the rupiah. Natural-resource exporters were also reminded to comply with rules to repatriate dollar earnings to shore up the nation's currency reserves.

Indrawati, during the interview in DC, said that while the strong dollar can increase the revenue from exports, it also risks adding inflationary pressures through imports.

Doubts over the incoming government's fiscal policy have also been keeping the rupiah under pressure, with foreign investors sidestepping Indonesia's debt market on concerns over Pesident-elect Prabowo Subianto's free-lunch program.

Without a clear financing strategy, the program could put Indonesia's debt load at risk and threaten its investment-grade sovereign rating, which was recently affirmed by Fitch Ratings and Moody's Ratings.

Indrawati, who will end her tenure as finance minister in October, said the budget deficit will remain under 3% and that Indonesia can sustain its 5% economic growth this year amid the higher-for-longer interest rate environment.

“Fiscal policy that is adjusting to many structural issues, but at the same time maintained in prudent principle is going to be very important,” Indrawati said.

Oil and gold jumped on rising geopolitical tensions after Israel struck targets in western Iran as a response to last weekend's attacks. One of the concerned cities is Isfahan, home to several military bases and facilities, but also to nuclear facilities including the main technology center. Iran said that the nuclear site is safe. Bloomberg journalists highlighted that as Iran's weekend attack – which was designed to warn rather than to destroy – Israel bombing remained in the 'realm of gaming out 'calibrated' actions to send messages without raising stakes. But uncertainty looms. Brent crude traded above the $90pb before easing to around $88.50 at the time of writing, US crude shortly trade past the $86pb level, wheat futures jumped 2%, gold rebounded to a near-record level and Swiss franc gained. We will likely see a further flight to safety before the weekly closing bell on fear of further escalation of tensions during the weekend. Shorting oil and gold is risky as Middle East is boiling. Having exposure to these commodities is a good hedge against the rising geopolitical tensions in the region.

In other hot commodity news, cocoa futures jumped close to 10% yesterday to above $11'000 per ton, and a hedge manager called Pierre Andurand said that the shortages will push the price of a ton of cocoa to $20K. For those who love speculation and adrenaline, cocoa futures is the place to be.

Elsewhere, tech investors didn't necessarily bought into TSM's better-than-expected revenue and earnings compared to the same time last year. They were rather disappointed with a 5% decline in revenue and income compared to the last quarter. The company dialed back its outlook for the chip market expansion due to weakness in smartphones, personal computers and car industry but said that accelerating demand for AI chips should compensate for that weakness and justify spending for capacity expansion and upgrades. They expect their revenue to grow at least 20% this year. But alas, anything less than mind-blowing is not enough for the chip rally to continue given the latest exponential rise. TSM shares fell nearly 5% after the results yesterday, while Micron Technology, which was up pre-market on news that they will get more than $6 billion in grants from the US government for their domestic factory projects, ended up falling almost 4%. The S&P500 extended losses and Nasdaq 100 retreated to near its 100-DMA.

Netflix reported results after the closing bell yesterday and surprised with a third month of blowout subscriptions growth. The company added more than 9 million new watchers in Q1 2024 and posted its best start to a year since the pandemic. The password sharing ban continued to boost Netflix subscriptions as company estimated that they were around 100 mio people using an account without paying for it. Apparently, the password sharing ban convinced a lot of them that Netflix is worth paying for. Unfortunately, Netflix lost almost 5% in the afterhours trading as its Q2 revenue forecast failed to impress. They also said that they will stop reporting quarterly subscribers next year… What a disappointment, that was the most interesting thing to watch in Netflix quarterly results… In terms of market price, Netflix will slip below its 50-DMA today and the toppish signs goes beyond Netflix.

US jobless claims came in lower than expected, the Philly Fed manufacturing index unexpectedly jumped . Fed's Raphael Bostic said that he doesn't expect a rate cut until the end of this year, Neel Kashkari said that the Fed could 'potentially' hold its rates steady all year and John Williams said that there is no urgency to cut rates and that he doesn't rule out a rate hike, though this is not his base case scenario. But the US 2-year yield remained capped near the 5% psychological mark despite strong data and hawkish comments indicating that investors are hesitant to give up their final hope of seeing the Fed loosen its policy.

The EUR/USD is under a renewed downside pressure as the divergence between the hawkish Fed and dovish ECB expectations justifies a further weakness in the single currency. The USD/JPY remained offered as core inflation in Japan eased more than expected by analysts to 2.6%. We are still waiting for the Japanese authorities to stop the bleeding as they said they would if the selloff became unsustainable…

The US futures are in the negative at the time of writing. The rising hawkish voices from the Fed back further weakness in stocks, especially the rate-sensitive tech stocks. Unfortunately, the quarterly results from the world's leading chip and chip equipment makers failed to satisfy this week and set the tone for a – maybe – challenging earnings season for chip companies. And if that's the case, we could see the risk rally fade into May… which is known to be the month where investors sell and go away.

The United States is an outlier among advanced economies, so how much signal should policymakers elsewhere take from recent upside surprises on US inflation? Less than some people seem to think.

Perhaps the issue didn't strike them as pertinent to a conversation with an Australian. Still, I could not help noticing that none of the offshore customers I have spoken with over the past two weeks were that shocked by the recent upside surprises on US inflation and retail sales. After all, it's not hard to end up with high inflation when your government is running a deficit of 6% of GDP, growth is above average and the labour market is already tight. So despite the 'shock and awe' reaction in financial markets, perhaps people were not that surprised after all.

As discussed last week, the US fiscal and consumer situations stand in contrast to Australia. In many respects, the United States is an outlier among advanced economies.

How much signal, then, should policymakers elsewhere take from recent US inflation surprises? It does highlight that, once inflation becomes domestically focused and driven by a high level of domestic demand, it can be sticky and hard to return to target rates. This is the source of the RBA's concern about market services inflation. While services inflation has so far declined in line with the RBA's earlier forecasts, the RBA is mindful that progress could stall, as it seems to have done in the United States. That said, as highlighted this week by Westpac's Head of International Economics Elliot Clarke, current high rates of services inflation in the United States have less to do with the components related to discretionary spending and more to do with slower-moving components such as insurance and medical services. Discretionary spending is high but lacks further momentum. So there are downside risks here as well as upside risks.

Another point of comparison is the role of housing-related inflation. In the US CPI, this relates only to rents, scaled up and adjusted to include imputed rents for owner-occupiers. In Australia (and Canada and New Zealand) rental inflation's weight in the total relates only to rents actually paid by renters. The contribution of owner-occupied housing to inflation is captured by the 'acquisitions method' – in other words, home-building costs. These, too, have increased significantly and in Australia they continue to escalate at an above-average pace.

The question is how long housing-related inflation will stay high. Across this group of economies, we have seen surges in population growth adding to demand for rental housing. At the same time, housing construction industries remain supply constrained, with domestic supply chains an issue in some cases. There is also a question of how much of the increased demand for housing represents a longer-lasting effect of increased working from home, which has seen some households needing more space than before.

If – as is the case for Australia and Canada – the population surge is largely a catch-up from pandemic-era restrictions, it should normalise over the next year or so. Indeed, this is Westpac Economics' projection for Australia's population growth, returning to the pre-pandemic norm of 1½% or a little above that in 2025. The rent component of CPIs relates to the stock of all rented properties, so it is slow-moving compared with most other components of inflation. But if we are right about the population surge in Australia being mostly a post-pandemic catch-up, then the burst of rental inflation should subside over time as well. (It would normalise even faster if the construction industry found a way to recover from current supply constraints.) The drivers of US population growth are somewhat different, and a slowing is not already baked into the dynamics there. This means that a slowing in US rent growth is less assured.

The upside risks to domestic inflation in countries such as Australia and Canada should not be dismissed. Given the nature of the housing-related inflation and the state of the consumer, though, neither should they be overblown. Recall that the Australian household sector has pulled back on consumption per capita in a way not seen elsewhere. Population growth initially masked this pullback from the perspective of the business sector. More recently, surveys are suggesting that businesses are now seeing the softness in demand and reacting to it, including in their pricing strategies.

We therefore cannot rule out – as a risk scenario, not currently our central case – that the conditions for withdrawing some of the restrictive stance of monetary policy will be met in Australia and some other economies before they are met in the United States. As we have explained previously, the RBA and other central banks do not need to wait for the Federal Reserve to move before they can do so. The RBA was cutting rates in the years leading up to the pandemic while the Federal Reserve was raising them. The signal from the US experience is as an example of what could happen elsewhere, not a direct linkage between rates decisions. It is also not the only such example. For this reason, watch the outcomes in Canada and Europe, not just the United States.

Some of the world's biggest investors are staying away from France's government debt, feeling underpaid to take on exposure to its deteriorating public finances.

France's budget deficit came in well above target at 5.5% of economic output in 2023, rising from the year before in contrast to other major euro zone economies.

The government has already hiked its 2024 deficit target to 5.1% from 4.4%. Deficit reduction plans lack credibility without further details to curb spending, France's public finance watchdog said on Wednesday.

None of this is likely to sound encouraging to credit ratings agencies, which begin reviewing the country next week.

Euro zone debt sustainability worries have typically centred on poorer Southern European states rather then the bloc's second largest economy and biggest government bond market with 2.46 trillion euros ($2.62 trillion) outstanding.

But unease around surging debt levels globally, including in the United States, is growing, with the IMF on Wednesday urging countries to rein in spending.

"We're heavily underweight French bonds," said David Zahn, head of European fixed income at Franklin Templeton, which manages $1.4 trillion in assets. "It's really the fiscal situation that concerns us."

France's finance ministry declined to comment for this article, but a government spokesperson told journalists on Wednesday its deficit reduction plans were "solid, coherent and responsible".

French bond yields have edged higher relative to top-rated Germany and the Netherlands in recent weeks, while lower-rated Italy and Spain's borrowing costs have narrowed relative to France's over the past twelve months.

Fitch, which downgraded France to AA- last year, and Moody's are due to publish their reviews of the country on April 26. S&P Global follows on May 31.

Moody's, which rates France Aa2, said last month that Paris would need to step up spending cuts. S&P Global's negative outlook on the country's AA rating raises the risk of a downgrade.

Chris Jeffery, head of macro strategy at Britain's largest investor Legal and General Asset Management, said markets are underestimating French risk.

Underweight French bonds since mid-2023, he notes Spain's credit ratings are several notches below France's despite a lower deficit and debt-to-output ratio - an "unsustainable" difference.

France has "some of the weakest macro fundamentals of the major European economies and the rating agencies are excessively generous to them because of their political status and size", Jeffery said.

The roughly 50 basis point premium France currently pays over Germany's debt is in line with 2022 and 2023's average, LSEG data shows, but is around double pre-pandemic levels.

Franklin Templeton's Zahn said French bonds weren't compensating investors for the risks and should trade like Spain's, which offer an additional 30 basis points in yield over Germany's debt.

However, investors said fiscal slippage may be tolerated for longer as France's bonds are seen as a relatively safe asset for the euro zone which faces a shortage of high quality debt, given the size of its market and its AA rating - the second highest category.

"We're neutral on France, because we just don't think that the fiscal story can cause enough volatility," said Schroders fund manager James Ringer, who expects France to retain its AA ratings for some time.

France may also benefit from economic growth which is still higher than the euro zone average.

France, like Italy, is expected to face a deficit reduction procedure with its budget gap unlikely to fall below the European Union's 3% limit, despite announcing 10 billion euros of budget cuts in February with a further 10 billion planned.

Markets have also shrugged off the risks in Italy where bonds have outperformed regional equivalents despite worse metrics than in France, albeit helped by a juicier premium.

Rabobank expects a French deficit of 3.6% by 2028 as interest costs surge. A fall below 3% would require the deficit excluding interest payments to stay near 0% for a few years, it added - challenging for a government which spends the most relative to output among developed economies.

Absent policy changes, Morgan Stanley sees France's debt rising to 132% of output by 2040 from 111% now, while it expects Spain and Italy's to be roughly unchanged at 111% and 136%, respectively.

France's scattered party system makes reforms harder, said Ales Koutny, head of international rates at Vanguard, the world's second largest asset manager.

Underweight France, he prefers Spanish debt.

Reforms or higher growth would mean "a better trajectory that would give us a bit more confidence to own French bonds," said Koutny.

($1 = 0.9385 euros)

The Federal Reserve's latest Beige Book shows that economic activity has expanded slightly since late February, and prices have been basically stable. Ten out of twelve Districts experienced either slight or modest economic growth, while the other two reported no changes in activity.

Consumer spending barely increased overall, but reports were quite mixed across Districts and spending categories. Several reports mentioned weakness in discretionary spending, as consumers' price sensitivity remained elevated. Auto spending was buoyed notably in some Districts by improved inventories and dealer incentives, but sales remained sluggish in other Districts.

Tourism activity increased modestly on average. Manufacturing activity declined slightly, as only three Districts reported growth in that sector. Contacts reported slight increases in non-financial services activity, on average, and bank lending was roughly flat overall. Residential construction increased a little, on average, and home sales strengthened in most Districts. In contrast, non-residential construction was flat, and commercial real estate leasing fell slightly.

In the labor market, employment rose slightly overall. Most Districts noted increases in labor supply and the quality of job applicants. Several Districts reported improved retention of employees. Despite the improvements in labor supply, many Districts described persistent shortages of qualified applicants for certain positions. Wages grew at a moderate pace in eight Districts. Multiple Districts said that annual wage growth rates had recently returned to their historical averages. On balance, contacts expected that labor demand and supply would remain relatively stable, with modest further job gains and continued moderation of wage growth back to pre-pandemic levels.

Price increases were modest, on average. Six Districts noted moderate increases in energy prices. Contacts in several Districts reported sharp increases in insurance rates. Firms' ability to pass cost increases on to consumers had weakened considerably in recent months, resulting in smaller profit margins.

Inflation would hold steady at a slow pace moving forward. There are upside risks to near-term inflation in both input prices and output prices.