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Weekly Focus – Fed is in a Difficult Situation amid Rising Stagflation Risks

In China, there is a lot of focus on China’s second-largest property group Evergrande, which is facing a default on a big part of its debt. Home sales dropped 20% y/y in August, which have added to the challenges for developers already feeling the heat from tighter regulation last year. The Chinese stock market has been hit hard but so far the financial stress in China has not spread to developed markets. This may change if things turn worse. A lot of focus on whether China announces new stimulus measures soon to offset the rising headwinds to the economy.

Besides that ‘stagflation’ has become a hot topic among economists and investors due to a combination of clear global slowdown signals and widespread bottlenecks/labour shortages (including still high inflation especially in the US). Our base case is a soft landing but as we believe the stagflation risks are on the rise. Challenges with the delta variant over the winter could prolong freight challenges and hamper labour supply further. A result could be rising wage pressures to levels not seen for a long time and a further increase in inflation expectations. If such a scenario plays out, central banks (in particular the Fed) are likely to tighten policy despite weaker economies. For more details see Research Global: Stagflation risks on the rise, 15 September.

The most important event next week is the FOMC meeting on Wednesday. After the weak jobs report and lower-than-anticipated CPI inflation print this week, we expect the Fed to wait a bit longer before announcing details on tapering. The tapering pace is going to be more important than the exact timing, given the strong signals that tapering is set to begin before the end of the year. We expect the Fed to signal one rate hike next year (up from zero) in the updated projections. For more details see Fed Research – Preview: What to do in a bad trade-off?, 16 September.

In the UK, we do not expect much new from the Bank of England, as it is one of the interim meetings. That said, the combination of high inflation and payroll employment now above pre-covid levels (although total employment remains subdued) means that risks are tilted towards a more hawkish Bank of England. QE is set to end by the end of the year and the question is whether the Bank of England will hike as early as in spring next year. Bank of Japan meets on Wednesday.

Also both the Riksbank and Norges Bank meet next week. Read more in the scandi section.

The German election takes place on Saturday next week. It is a close race and we believe there is an equally likely probability for a ‘Jamaica’ coalition (40%) led by the CDU/CSU and a ‘traffic light’ coalition (40%) led by the SPD. Only a major election surprise has the potential to trigger significant market moves, in our view. For more details see German Politics Monitor: The tables are turning left, 9 September.  

Next week, preliminary PMIs for the euro area, the US, the UK and Japan are due out on Thursday. We are looking for further signs that we have seen a peak in manufacturing. The subcomponents are likely to show that there are still many bottlenecks globally.

Full report in PDF.

Danske Bank
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