In early April, a rare total solar eclipse delivered a ‘once in a lifetime’ experience to north America dwellers. Following weeks of media build up, for a few people the eclipse delivered a celestial spectacle. For many more, whose line of vision was obscured by pesky clouds, the occasion provided a transitory sliver of disappointed excitement in an otherwise largely predictable panorama.
It’s been a bit like that in financial markets of late. The long-trailed cuts in interest rates that had been slowly coming into view look like they might now be outshone and overshadowed by resurgent inflation.
From day to night
From expectations of six US rate cuts this year the market consensus has now shifted to just two. On 17 April, Bloomberg was reporting that futures markets were now showing investors expected rates to fall by just 40 basis points this year, compared to 150 basis points priced in at the start of 2024. And the likelihood of no easing this year is being considered a realistic possibility after three consecutive months of upside surprises to US inflation data.
Implied number of cuts from the US FED: less than 2 priced in for the year
Source: Macrobond, as of 17/04/2024
The pickup in inflation versus expectations is coming almost exclusively from services. The Federal Reserve has repeatedly emphasised the importance of service inflation as it is linked to rising wage costs. Our inflation base case remains optimistic on wage growth falling. The next important data print will be the Employment Cost Index due for release at the end of the month.
Contributions to US CPI: Services dominates
Source: Macrobond, as of 17/04/2024
The signs had been emerging that the global economy is proving more resilient to higher interest rates than feared. Consumption is booming and commodity prices have been ramping up. Spot gold hit a new high on 16 April1. Initially, this could have been brushed away as central bank buying, notably by China, as a reserves diversification and cautious pivot to safe assets amid geopolitical concerns (the latter is also traditionally a driver for many other investors). However, while gold has been in the spotlight, the upward creep in copper is far more telling in terms of the story for economic growth and inflation.
Gold Reserves, Volume, IMF: Emerging Market Central Banks are buying
Source: Macrobond, as of 17/04/2024
Industrial metals broadly have been extending their gains. Prices for copper, zinc, tin and, and even iron ore, subdued by China’s property downturn, have been on the rise2.
This links to activity and expectations in global manufacturing. But copper, used in everything from electric vehicles (EVs) to wind turbines and power grids has the advantage of being a key ‘green’ metal with no substitute in EVs, wind and solar energy. As a result, its appeal to investors should continue to support price rises into the medium term.
Copper and iron prices: Diverging
Source: Macrobond, as of 17/04/2024
Manufacturing’s rebound
Some market commentators have linked the rally in metals prices to China’s industrial recovery strategy but economic data released this month suggests broader global foundations. For instance, German industrial production was reported to have risen more than expected in February and U.S. manufacturing too showed expansion in March, for the first time in one-and-a-half years3,4. Purchasing Managers Indices are a useful survey indicator for overall real economic activity. Above 50 indicates expansion and below 50 contraction. On a global basis the strength of the services sector of the economy, led by the US, was key to averting recession over the past year. We are now seeing a recovery in the more capital-intensive manufacturing sector.
Global Purchasing Managers Indices: Manifacturing picking up
Source: Macrobond, as of 17/04/2024
The UK’s manufacturing sector also returned to growth this Spring, for the first time in 20 months. Figures from the S&P Global Market Intelligence/CIPS UK manufacturing PMI survey hit 50.3 in March, up from 47.5 in February5. Forward-looking sentiment also improved with some 58% of companies saying they expect output to rise over the coming year.
The impact of Chinese demand cannot be understated, however. Its economy is large and undergoing a major transition in the form of a tilt towards clean energy and high-tech manufacturing. Three new growth drivers in particular are evident: (EV’s), batteries and solar panels.
As China looks to offset the slump in traditional sectors like property, the rotation towards the ‘green’ economy will gain traction. Last year saw rising demand for renewables and EVs in China. BYD, which has emerged as China’s biggest EV maker, could even expand capacity to tap into more price conscious overseas consumer markets, closing the gap with its closest global rival Tesla.
India, which has been much slower than China to build and adopt EVs and related charging infrastructure, is also looking to the green economy for additional job creation. In this election year, the Modi government has been visibly courting Elon Musk to enter into a joint venture to establish a manufacturing facility in the country.
The scramble to re-adjust
China remains one step ahead, with a rapid expansion in copper smelter facilities and capacity also in the works. As well as feeding its own domestic needs, this move is likely driven by the development of increasing demand from the green energy sector globally. It certainly provides another useful lever in its overall growth strategy. Last year China’s production of refined copper surged 13.5% year-on-year to 12.99 million tonnes, according to data from China’s National Bureau of Statistics6. A fortuitous and timely expansion as prices for the commodity track higher.
Chinese copper stock: Increasing rapidly
Source: Macrobond, Shangahi Futures Exchange, data since 2003, as of 17/04/2024
An end to the Federal Reserve’s interest rate tightening, which has contributed to a stronger dollar and a drag on the demand for industrial metals over the past two years, is fading out of effect.
While the rebound in manufacturing is good for global growth prospects, a large rise in raw material prices could hamper progress on inflation. We don’t forecast a big move and expect the Fed’s focus to remain around wage growth. As the prospect of rate cuts dims, many investors who had built up positions in equities and bonds over the last few months, are left in a dilemma; how to adjust their portfolios?
Maintaining our bond overweight
The world economy is improving and the move in commodity prices reflects the expansion in the manufacturing sector. The US aside, inflation is falling. Bonds look attractive given market moves and we maintain our overweight position.
