Macro Insights: Inflation threat means upside risks to tightening path for Fed and ECB

The official start of QT and no Fed pivot yet. The Fed starts to reduce the size of its balance sheet from today, starting with $30 billion in Treasuries and $17.5 billion in mortgage-backed debt, but picking up pace to a monthly cap of $95 billion by September. The big risk-on move we saw in the US equities last week has led to some easing of financial conditions. But higher oil prices following the Eurozone’s embargo on Russian oil are bringing inflation concerns back to the table. Not that they ever went away. Comments from Fed’s Waller have confirmed that there isn’t a Fed pivot in sight yet, and Fed’s Bostic has also said that he didn’t suggest a Fed put with his comments last week after a September pause started to get priced in. We are bracing for more hawkish Fed commentary with Williams and Bullard on the wires next.

China reopens but supply chain pressures to persist. While the sentiment has been supported recently as China resumes manufacturing in Shanghai, but we remain sceptical about the impact on shipping delays and supply chain pressures. As China’s factories resume operations, demand for raw materials is also likely to pick up and further congestion cannot be ruled out. My colleague Chris Dembik has noted in this piece that lingering supply chain difficulties will continue to weigh on economic activity and push up prices.

Eurozone inflation leaves the door for 50bps rate hike open. The Euro-wide CPI rose to all-time highs of 8.1% y/y in May, higher than last month's 7.5% and the consensus estimate of 7.8%. The print is likely to make the ECB policymakers open to more aggressive tightening moves after a move to exit negative rates in Q3. Core inflation was above expectations as well at 3.8% y/y and with inflation broadening to services, it will likely be stickier too. Furthermore, oil sanctions announced by the EU have added to expectations of oil prices remaining at an elevated level as well. While many ECB policymakers, including chief economist Phillip Lane yesterday have tilted towards preferring the gradual path of President Christine Lagarde of 25bps in July and September, we cannot rule out further support for a more aggressive move as well.

Vietnam outperforms Asia’s manufacturing PMIs. Vietnam’s manufacturing PMI rose to the highest since April 2021 at 54.7 in May from 51.7 earlier, with both output and new order rising. Other regional PMIs were marginally lower but remained broadly in expansion. Vietnam’s move away from the pandemic curbs is broadly helping with the expansion of the manufacturing sector and China’s reopening adds further tailwinds. Headline inflation has surged to a 12-month high of 2.9% y/y in May, still remaining below the target of 4% but threat of further gains remains.