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SPI Management Newsletter 30.09.2022

IMF urges UK to ‘re-evaluate’ tax cuts in an unprecedented attack on fiscal plan

The IMF heavily criticised UK’s plan to implement £45bn of tax cuts, requesting the government to “re-evaluate” the plan and warning that the “untargeted” package is likely to worsen the already high inflation which the BoE is attempting to combat. This was an unusually sharp criticism of the decision made by a G7 country.

Meanwhile, the Bank of England (BoE) has announced it would purchase as much government debt as necessary to support UK's bond markets. Additionally, Prime Minister Truss will have an emergency meeting with the Office of Budget Responsibility, an independent fiscal watchdog, to further address the potential impact of the previously announced tax cuts.

Sterling, after dropping to historical lows on Monday, has now recovered to previous levels, trading around $1.1118 early Friday morning. However, GBP will likely come back under pressure if the expected surge in global yield resumes.

The effects of the Fed's monetary tightening are felt worldwide

The central bank expects to raise the federal funds rate to nearly 4.5% by the end of the year and higher still in 2023. These rate hikes are playing a significant role in the surge of the US dollar which has increased by 5.5% since mid-August on a trade-weighted basis.

Outside the US, the fiscal impact of the Fed's tightening has been the most severe. A stronger dollar is hurting energy importers already struggling with rising costs. China responded by making it harder to short the yuan, which hit a record low against the dollar on Sept. 28. India, Thailand and Singapore have intervened in financial markets to support their currencies. JP Morgan Chase said foreign exchange reserves in emerging markets excluding China fell by more than $200 billion last year, the fastest decline in two decades.

In fact, a strong dollar exports the US domestic inflation problem to weaker economies. They can support their currency by raising interest rates in line with the Fed, but at the cost of even lower growth. Developed countries can usually withstand a stronger dollar. Today, they are showing greater signs of immediate stress.Some of the worst-performing currencies in 2022 come from the affluent world (Sweden, UK, Korea). Part of the explanation for the pressure on developed market currencies is that many central banks have yet to catch up with the Fed tightening and their economies are weaker than the US.

Chinese economy is rebounding

Both retail spending and industrial production indicators have shown growth in China after multiple negative months.This is most likely due to the positive effect of lessened COVID-19–related restrictions. The Chinese government reports that, in August, retail sales were up 5.4% from a year earlier, the best performance since February. Sales were up 15.9% for automobiles, 17.1% for oil products, 5.1% for apparel, and 3.4% for home appliances. On the other hand, sales were down 6.4% for cosmetics, down 8.1% for furniture, down 4.6% for telecoms equipment, and down 9.1% for building materials. The decline in housing-related categories reflects ongoing problems in China's housing market.

The recovery now faces three notable headwinds:

  • The troubled real estate sector

  • Financial stress from the global tightening which has gained momentum

  • Government zero-tolerance policy regarding COVID-19.

China’s official manufacturing Purchasing Managers’ Index surprisingly grew in September to 50.1, much higher than the 49.6 predicted by analysts in a Reuters poll - positive news for the economy.

Adapted from WEF, CNBC, IEA, The Economist, FT

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