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Economy in Brief

Charts of the Week (Sep 23, 2022)
by Andrew Cates  September 23, 2022

Against a backdrop this week of enduring geopolitical tensions, as well as the Fed's latest decision to lift interest rates, the strength of the US dollar remains a key focal point for financial markets. With that in mind, our first chart looks at how the dollar has performed in recent months compared with previous Fed tightening cycles. In the meantime, the fragility of China's real estate sector and broader economy – a theme in our second chart this week – are generating ramifications for export growth in its key trading partners (e.g. South Korea) - a theme in our third chart. As for Europe, the tremendous challenges that confront both the Bank of England and the European Central Bank in setting interest rates at present are underscored in our following two charts concerning energy prices and peripheral bond market spreads. Finally, we look at some lower-frequency economic data that offers some perspective about the potential capacity lurking in global labour markets.

The US dollar

The trade weighted value of the dollar (measured with reference to the Fed's Advanced Economies Index) has risen to a near-two-decade high in recent weeks. That's in part a function of geopolitical stress and the heightened risk aversion this has invoked in financial markets. But it's also, in part, a function of the Fed's campaign to tighten monetary policy. Measured though with reference to previous Fed tightening campaign, the US dollar is still unusually strong. In Chart 1 below we look at how the dollar has evolved in the 6 months before, and the subsequent months after, the Fed started to lift interest rates over the last 40 years. In many of those tightening phases, the US dollar actually weakened in the immediate period after the Fed started to lift rates. Partly for that reason, the latest phase from March 2022 has yielded the strongest performance from the dollar by some margin.

Chart 1: The performance of the US dollar during Fed tightening cycles

China's housing market

One reason for that strength is the weakness that's being exhibited by other major economies. Economic activity in China, for example, is still below normal, in part because of the restrictive policies that are being pursued to counter COVID. From an even broader perspective, however, the ongoing deterioration in sentiment toward its real estate sector is also pulling the economy down (see chart 2).

Chart 2: Deteriorating sentiment in China's real estate sector

South Korea's trade

This week's trade data for South Korea, covering the first 20 days of September, underscored how that weakness in China is generating reverberations for its major trading partners. Export growth, for example, fell by 8.7% y/y from +3.6% in August. The weakness of export growth was broadly based to its key trading partners but it was particularly weak to China and Europe.

Chart 3: Sharply slowing export growth in South Korea

UK inflation expectations

The Bank of England's monetary policy committee (MPC) lifted its key Bank rate this week by a further 50bps, in line with most economists' expectations. That the hike was not 75bps (which a few economists had expected) could be in part because MPC members are acutely aware of the difficulties in setting UK monetary policy at present. Energy and food price inflation – which are insensitive to shifts in interest rates - have played a much bigger role in driving UK (and broader European) inflation higher in recent months relative, for example, to the US. One counter to this is that monetary policy should still play a big role in containing inflation expectations following spikes in oil (and food) prices but expectations are heavily swayed by shifts in energy prices as well (see chart 4 below).

Chart 4: UK longer-term inflation expectations versus oil prices

Italy's upcoming election

A further headache for the European Central Bank at present is the potential for some flare up of political instability in Italy. The right-wing coalition, led by Giorgia Meloni's Brothers of Italy party, is currently favourite to win that election according to the latest polls. Heightened concerns about what this might yield for economic policy amidst already-high levels of debt have already caused bond market spreads to widen in recent weeks (see chart 5). Market participants might question the ECB's willingness to intervene in Italy's debt market if financial instability were to become more entrenched.

Chart 5: Bond market spreads in France, Italy and Spain

The global labour market

Local, regional and national labour markets have been heavily impacted by supply side bottlenecks in recent months, many of which have been caused by – or are a legacy of – the pandemic. Lockdowns, long-term sickness, work-from-home policies, as well as much lower immigration levels have lowered participation rates, stifled job rotation and squeezed potential pools of available workers. As a result, and measured with reference to the demand for workers (i.e. job vacancies), many domestic labour markets are tight.

But measured with reference to the pool of workers that's potentially available in the world as a whole, labour markets are not as tight. According to the World Bank the global unemployment rate was 6.2% in 2021. Apart from the COVID afflicted level of 6.6% in 2020, this was the highest level for over 30 years. Obviously, access to that pool of labour is not easy (contingent on the sector concerned). But new technologies have been making it much easier for companies to access this labour potential in recent years and going forward should continue to make it easier. Around 60% of the world's population had access to the internet in 2020, for example, more than double the proportion at the start of the previous decade (see chart 6).

Chart 6: Gauges of the potential capacity that exists in the world's labour market

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