INFLATION FEARS ABATE FURTHER

WHAT YOU NEED TO KNOW

The sustained fall in US inflation alongside the reopening of China’s economy and a warmer-than-normal European winter brought hopes of a more optimistic start to 2023 than initially feared by markets.
The falling US inflation data was welcomed by equity and government bond indices, which closed the week higher across the board, while the US dollar softened.
In portfolios, we currently have a higher weighting towards high-quality bonds as we believe interest rates will peak in 2023. On the equity side, we increased exposure to quality US and attractively valued emerging market equities over those in the euro area. We also expect a softer USD vs the EUR and GBP.

Markets

Up two weeks in a row

Equities continued to rebound across the board, with emerging markets outperforming their developed peers (which also saw gains) so far in 2023.
Sovereign bonds drifted lower on softening inflation in the US, France, and Spain.
The US dollar softened across the board on better risk sentiment, with the euro gaining the most.

Central banks & inflation

Moving in the right direction

US CPI inflation in December fell to 6.5% in line with expectations, largely driven by energy costs.
Several Fed speakers have hinted at a potential slowdown in the pace of rate hikes. Markets cemented their view of a 25-bps hike, though given ongoing labour market strength, a half-point hike in February is still a possibility.
Chinese consumer inflation rose to 1.8% driven by higher food costs, although core inflation is muted at only 0.7% (year-on-year).

Economy

A better winter than initially feared

The University of Michigan consumer sentiment rose further in January 2023, the highest since April 2022. Both current conditions and expectations improved while the year-ahead inflation expectations fell for the fourth straight month.
In the Eurozone, industrial production rose 1.0 % m/m, showing signs of resilience following a sharp decline in October 2022. Germany, the Eurozone’s biggest manufacturer, saw its economy expand 1.9 % in 2022, which may mean it avoids a winter recession.
UK GDP edged up 0.1% m/m in November driven mainly by services activity.
China’s imports and exports contracted again in December. However, China has now fully reopened, which should propel domestic demand.

US retail sales and industrial production (Wednesday), as well as US housing market data (Wednesday and Thursday), could show signs of pressure which may lead to the Fed concluding its rate hiking cycle sooner than expected.
In Europe, the German ZEW economic sentiment and current conditions surveys (Tuesday) are expected to recover considering the improved energy market outlook.
UK headline inflation (Wednesday) is likely to remain stable, curbing UK consumer confidence (Friday).
In Asia, China GDP Q4 (Tuesday) is projected to have fallen on a quarterly basis. In addition, industrial output and retail sales in December (Tuesday) are expected to weaken. Investors will be keen to see any news from Chinese officials on loan prime rates (Friday).
The Bank of Japan is set to hold its policy rate at -0.1% (Wednesday), however, headline inflation in Japan (Thursday) could rise to 4% year-on-year.