Author: Pawel Kudzia

Rate cycles seem peakish – though forward guidance from the central bankers at the Federal Reserve’s Jackson Hole symposium were testament to conveying “data dependency”: they’ll be monitoring how economic data will evolve and be revised, and thus keeping rate optionality open. Inflation remains the dominant factor driving policy stances, but these stances vary by country.

Recently, China cut its central bank’s reserve ratio requirement by 25 basis points following dovish data releases. By contrast, last week the European Central Bank raised rates by 25 basis points to curb inflationary pressures. The ECB signaled (and the market assumes) this was likely the end of the rate-tightening cycle, but again made reference to data dependency, theoretically keeping the door open for another hike.

As we begin a policy-heavy week – with the Fed, Bank of England and Bank of Japan announcing rate decisions between September 20 and 22 – how have economic data in these countries evolved?

Data releases and market positioning point towards a September pause from the Fed, a 25-basis-point hike by the Bank of England, and a further relaxation in Japan’s yield curve control policy.

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The following chart looks at “surprise” indices from Citigroup that track whether economic or inflation data releases are beating or trailing expectations.¹ A broad classification for countries can have data indicating: “stagflation surprise,” “hawkish surprise,” “dovish surprise” or “Goldilocks” scenario:

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Over the last three months, the US has seen an increased number of upside economic surprises, as has Japan. (Both nations are now in “Goldilocks.”) The UK has had markedly fewer hawkish surprises. China’s data remained dovish.

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United States

A weaker US labour market is not a concern yet. Non-farm payrolls rose by 187,000 in August. JOLTS (Job Opening and Labor Turnover Survey) data has held up, with the seasonally adjusted job openings rate at 5.3 percent.

Core inflation has remained sticky. The core consumer price index (CPI) inched up 0.3 percent month on month, and core headline inflation was 4.3 percent for August. Energy had been pulling down inflation prints, but with higher crude prices, there could be an upward push ahead. The 2 percent CPI target remains far away.

As 2023 progressed, the Fed “pivot” that was widely anticipated was deferred further into the future. As the next chart shows, the futures market currently suggests that the Fed will “pause” this week, hike by another 25 basis points before the end of the year, and not start cutting until the second half of 2024.

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United Kingdom

Inflation remains relatively high in Britain versus other economies: CPI stood at 6.8 percent for July. The labour market is losing steam, with unemployment climbing to 4.3 percent – the highest rate since 2021 -- though cost-of-living pressures are easing as wage growth catches up with inflation.

This stubborn wage growth – a median of 6.7 percent, on a three-month moving average – could well push core inflation higher and keep it above the 2 percent target. The next chart shows how wage increases are distributed across Britain, with London trailing other regions.

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Japan

The Bank of Japan tweaked policy in July, allowing a greater range of government bond yield tolerance. This was followed by positive economic data surprises: stronger purchasing managers index prints (services PMI was 54.3), higher services inflation (which breached 2 percent), the highest pay increases in 30 years (an increase of about 4 percent announced by the government during labour negotiations) and the USD/JPY exchange rate reaching levels that last led to a Bank of Japan intervention in 2022.

Most data points suggest a gradual move towards policy normalisation from the current ultra-accommodative policies; relaxing the yield curve control cap further might well be considered.

¹ Citi Inflation Surprise Indices are quantitative measures of inflation releases relative to market expectations. A positive reading of the Inflation Surprise Index suggests that inflation has on balance been higher than expected in recent history.

Citi Economic Surprise Indices are objective and quantitative measures of economic news. A positive reading of the Economic Surprise Index suggests that economic releases have on balance been beating consensus.

Global central banks have focused on one problem – inflation – since the start of 2022, resulting in steep rate tightening around the world.

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The evolving macro dynamics during rate-tightening cycles impart substantial volatility and impact valuations for every asset class. 

The risk-off sentiment and higher rates raise a genuine temptation: should cash allocations be raised for capital preservation?

We are sceptical, considering the outlook for growth and inflation and the historical performance of different asset classes. For tactical asset allocators, there are favourable investment opportunities vis-à-vis cash, considering various investment horizons and macro scenario pan-outs.

Macro projections indicate room for both equities in the short term and government securities over the medium term

Rate-tightening cycles usually bring in risk-off sentiment in the markets. Tighter policy usually leads to higher borrowing costs for corporates and households, more expensive investments and consumption, risks of slower growth and a move to safe-haven assets.

Rate hikes and future rate expectations influence economic outlook, business cycles and shape-up varying demand for asset classes. Equities are supported by healthy growth prospects, while a recessionary outlook tends to benefit assets like UK gilts.

The Bank of England is projecting more rate increases through early 2024 to bring down inflation; its economic scenario anticipates slowing (but positive) growth. Until then, despite the not-overly-positive economic backdrop and given short term volatility, an overweight call on equities remains supported by earnings and dividend projections.

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As the projections in the chart above reach the end of 2024, real GDP growth heads to zero – and the Bank of England seems to anticipate cutting interest rates. 

The current yield curve (which is steeply inverted) would, by then, imply a bull steepening of the curve – with the shorter end of the curve falling faster than the longer end. 

Such a disinflationary recession outlook would likely call for investors to be overweight governments bonds in the second half of 2024, anticipating capital gains driven by rate cuts.

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Cash has tended to underperform in past cycles

This table tracks the performance of various asset classes relevant to a UK-based investor since 2016. We also added 2006, an example of a year that was late in a rate-hiking cycle.

Returns in USD terms for comparison, unless stated otherwise

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Anticipation of better growth prospects (2006, 2017, 2019) in the UK led to relatively solid equity returns. Uncertainty post-Brexit (2016) and amid the Covid-19 outbreak (2020) led to outperformance by gilts. Commodities (especially gold) provided a better hedge against rate tightening in 2006, 2017 and 2018 than cash did.

The return on cash (computed as Bank Rate adjusted for inflation) has largely underperformed other investment options across rate cycles, and has yielded negative returns since 2008. The mean cash return stands at -2.2 percent since 2009. This chart shows how cash remained a poor hedge against inflation.

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Prudent asset allocation can outperform the allure of cash

Cash becomes an interesting option around tricky inflection points closer to the end of rate hikes. 

So far in 2023, higher interest rates have not dampened growth significantly, and commodities and equities have outperformed cash.

Central banks are hoping for a soft landing, whereby inflation softens in the backdrop of sustained growth. This would have been ideal for equities over the medium term, too. However, it’s unlikely, as inflation may be sticky and remain above target for most central banks – which wouldn’t pave the way for rate cuts in the near term. 

The Goldilocks scenario is unsustainable, and macroeconomic data is likely to mark deterioration going into the second half of 2024. A slowdown and recessionary outlook may result in monetary easing – spurring demand for government securities.

Given these evolving scenarios, diversified and tactical asset allocation – targeting capital gains and hedging for inflation – can be structured and fine-tuned.

At the BRICS summit last week, the five-member group of developing nations (Brazil, Russia, India, China and South Africa) agreed to expand the alliance further to include Argentina, Ethiopia, Iran, Saudi Arabia, Egypt and United Arab Emirates. The new members will join in January.

In a multi-polar world, the members of BRICS are motivated by a desire for balanced globalisation and governance – and are especially interested in reducing the role of the greenback in global trade, given the reach of the US sanctions regime and how it has complicated trading in oil (which is priced in USD). Notably, the new members include prominent OPEC nations.

Will they succeed in “de-dollarisation,” reducing the role of the global reserve currency? First, some background.

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BRICS expansion is coming after the US has seen its steepest-ever rate-tightening cycle, which along with the greenback’s safe-haven status has led to a sharp appreciation in USD. 

Such appreciation can hurt emerging-market nations in several ways: 1. Dollar borrowings get more expensive; 2. Twin-deficit countries can be compelled to control inflation and manage their exchange rate via rate hikes; 3. Capital flow vulnerability; 4. Current-account surplus countries fund US trade and budget deficits via investment in Treasuries, and 5. US can thus avoid external imbalances at the cost of macro vulnerability and deflation fallout in other nations.

Given this backdrop, the next chart shows how BRICS currencies have been more volatile against the USD than the G7 nation currencies even considering the Japanese yen volatility, for instance.

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This provides the context for BRICS expansion. The nations are seeking both a multipolar geopolitical world and potential “de-dollarisation” – starting with members gradually encouraging using non-USD currencies to facilitate trade.

Multipolarity: BRICS countries have common interests that differ from the Western alliance. The original five members also had their own geopolitical reasons for supporting expansion. In Iran, Russia adds one of its allies to the bloc. China supported membership expansion to promote the bloc’s economic heft. Brazil's president is advocating a common BRICS currency. India is seeking a geopolitical balance to its relationship with the US. 

As for the oil trade, the inclusion of Saudi Arabia, the world’s largest crude oil exporter, could further support the development of oil payments in non-dollar currencies by China – the world’s biggest oil importer – and other member nations. And six of the top 9 oil-producing nations will be part of the expanded BRICS.

De-dollarisation: BRICS leaders are at odds with a single, all-powerful reserve currency. While there is some talk of a common currency being established (which is not viable or likely in the near future), a more plausible outcome would be the gradual increase in member nations trading in their own currencies to reduce the reliance on USD. 

Indeed, the aggregate economic and demographic heft of the expanded BRICS is notable, as the following two charts show. There are favourable demographics (3.7 billion people, about 40+ percent of the world’s population), vast natural-resource wealth, and an aggregate holding of 40 percent of global foreign exchange reserves.

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IMF projections estimate the expanded BRICS will contribute about 39 percent of global GDP by 2028, as the next chart shows – the result of growth that will outpace global GDP for most member countries.

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More steps towards de-dollarisation: 

This research paper, published by Cambridge University Press, examines how the BRICS have developed multiple de-dollarisation initiatives to reduce currency risk, bypass US sanctions and establish critical infrastructure for a prospective, alternative global financial system.

In the wake of sanctions on Russia and its expulsion from much of the global financial system in 2022 due to the Ukraine war, the nation’s non-western allies could move away from using the USD.

The BRICS’ development bank has been lending in Chinese yuan, and announced it would make loans denominated in the currencies of South Africa and Brazil.

And as the next chart shows, BRICS central banks are adding ever more gold to their reserves of foreign currency.

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Meanwhile, the USD is declining as a share of central bank reserves on a global basis, as IMF data in the next chart shows. The greenback fell to a 20-year low of 59 percent in March, while the Chinese yuan’s proportion has risen steadily since 2017, reaching 3 percent.

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However, de-dollarisation is not imminent. The dollar still dominates global trade – and is one side of almost 90 percent of the world’s foreign-exchange transactions, according to the Bank for International Settlements. And as the next chart shows, the dollar has grown to 46 percent of all global payments made through the international SWIFT network.

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Dislodging the dollar would take the creation of a lot of financial infrastructure and economic and geopolitical convergence, including a common BRICS central bank and fiscal union.

Moreover, countless businesses and traders around the world would independently need to decide to use a currency other than the USD. And investors used to the safety and liquidity of Treasuries would need to be willing to hold a non-USD equivalent.

Given all of the moving parts, it will take years for the BRICS to drive their de-dollarisation agenda. But for now, BRICS expansion adds economic might to the bloc and supports gradual complementarity – above and beyond the powerful symbolism. 

Despite the small size of some of the new members and the varied interests of the BRICS countries, the dollar’s dominance is being questioned and may well be challenged over the long term.

The US consumer price index has been benefiting from a long time lag inherent to the way health-care costs are computed. That benefit is set to wane.

Let’s examine this phenomenon by first inspecting the inflation figures for July. Headline CPI was 3.2 percent. Core CPI, which excludes energy and food prices, was 4.7 percent. As the first chart shows, this broadly follows the softening trend seen through the year.

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Next, let’s turn to a heatmap that breaks down current inflationary or deflationary trends in different industries. Which of these eight sectors are having the greatest effect on the CPI?

As the heatmap shows, the “coldest” sectors are transport and medical care. The latter accounts for a weight of almost 8 percent in the CPI, and will be the focus of this blog post.

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The CPI’s medical care index can be further divided into medical care services and medical care commodities. Medical care services can be further broken down to (a) professional services, (b) hospital and related services, and (c) health insurance. 

The “cold spell” in that heatmap is at odds with the historic trend. Medical care inflation, led by medical care services (up 114 percent since 2000), has outpaced overall inflation (81 percent) in the economy – as the next chart shows.

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The measurement of the health insurance component of the CPI is particularly tricky.

Instead of measuring the change in premium prices directly, an indirect method based partly on health insurers’ profits – rather than the premiums those insurers set – is applied. Thus, the data is lagged by almost a year, and isn’t representative of current price changes.

The Bureau for Labor Statistics’ Retained Earnings Method involves four steps: 1) separating health insurance index weights, 2) calculating the retained earnings ratio, 3) health insurance index aggregation, and 4) reassigning health insurance weights. This implies steep changes, with retained earnings component reset and stepwise changes in the weights.

The calculations in this method can have a lumpy impact on the healthcare insurance index.

The next chart breaks down contributions from medical care index sub-components ranging from hospital services to drug prices. Note how the change in the health insurance component, in green, has shown sharp volatility throughout 2022-23. 

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The surge in September 2022 healthcare inflation embedded health insurers’ better margins from the early Covid years, given the lower claims paid during lockdowns. However, returning utilisation implied lower margins, on average, in 2021 and 2022.

This September 2022 index computation and weight redistribution provided a higher base and decreasing inflation prints throughout 2023. Health insurance CPI slowed dramatically -- from an annualised increase of 28.2 percent in September 2022 (the all-time high) to a decrease of 29.5 percent in July 2023. 

The comfort from this moderation is only expected to continue until September 2023. 

Late last year, a report from the Kaiser Family Foundation predicted that employer-sponsored health insurance premiums would rise more steeply in 2023 than they had in recent years.

The steeply negative trend in healthcare insurance inflation will likely reverse beyond the fall season – and coupled with higher wages for medical care workers, the benefits stemming from this negative contribution to overall core CPI will likely abate. 

As our final chart shows, we see core CPI staying in a tight range for the next few months. Base effects will support a marginal softening in headline core inflation prints going into the year-end – but they will stay above the Federal Reserve’s target. 

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Japan’s first real inflation in over 30 years is causing a revolution across the economy. Wage hikes may be the new norm, with companies taking a cue from central bankers and announcing forward guidance for wages.

The weak yen, which was a major driver of inflation, is fueling a tourist boom. Meanwhile, the global semiconductor shortage has moved from being another factor in higher prices to triggering a foreign investment-led renaissance in Japan’s tech sector. Capital spending could hit a new record. 

Behind the scenes, the Bank of Japan remains supportive. While it tweaked the yield curve control policy recently, it seems unlikely to engage in true tightening that would constrain the economic boom that’s underway.

Nominal GDP for fiscal 2023 is expected to grow by 4 percent, according to a Nikkei survey – the most in 32 years. Meanwhile, the IMF forecasts that real GDP will grow at the third-fastest pace in the G7, as the next chart shows.

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Then there’s the output gap, which is closely watched by policymakers. It’s the difference between actual GDP and potential GDP. 

Thanks to the boom, Japan’s output gap is about to move from negative to positive – i.e., from being deflationary to inflationary. 

One factor is the boom in tourism. Originally driven by the cheap yen, department stores say this trend has entered a second phase, thanks to an influx of Chinese tourists¹. 

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Consumer confidence has improved for five consecutive months. Indeed, the Cabinet Office used the word “improvement” in this context for the first time in nearly ten years.‍

Breaking a 30-year trend

Interestingly, the trigger for the boom was inflation. Excluding the effects of subsidies, inflation has reached 40-year highs, surpassing 4 percent. (For most of Japan’s post-bubble period, it hovered between zero and 1 percent, leaving consumer prices almost totally stable for 30 years, as the next chart shows.)

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What is responsible for this sea change? The Bank of Japan’s monetary policy played a key role. 

Inflation was exacerbated by the weak yen, which depreciated due to the widening interest rate differential with the US. As the US hiked policy rates by over 5 percent, Japan stayed put. 

A weak yen boosts import prices – and Japan imports about 80 percent of its energy and 70 percent of its calories. Unsurprisingly, food and energy drove the inflationary trend, as the next graph shows. 

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Wages at a time of extreme labour shortages

The inflation also sparked wage hikes –welcomed by the Kishida administration, which wants household incomes to rise as a top political priority. 

According to Rengo, which represents 5,000 unions across multiple industries, workers recently won their highest wage hikes in 30 years². And, surprisingly, public- and private-sector officials both say such wage hikes may be becoming the norm.

Besides keeping up with inflation, the wage gains are partially due to the extreme shortage of workers. Japan’s labour market tightness for prime-aged workers (25 to 54 years old) is the most extreme among major nations, according to OECD data visualised in the next chart. 

Major construction companies are now turning down short-term projects, unable to find enough workers. And most interestingly, that “forward guidance” on wages is manifesting itself, with companies specifying the trajectory of employee pay for prospective workers: one firm promsed 4 percent increases per year through 2027³. 

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For now, the pay gains are trailing inflation, meaning real wage growth is negative. But thanks to massive energy subsidies and more stable trading for the yen, inflation has slowed. And if wage hikes continue, real wage growth could turn positive. 

As the next chart shows, import prices are rapidly slowing and are expected to drag overall inflation down. Food prices, the main driver of inflation in Japan, are now expected to slow, according to Teikoku databank’s food manufacturer price surveys⁴. 

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The BOJ’s latest tweak

Late last month, the BOJ announced another tweak to its yield curve control policy, which manages trading on 10-year government bonds. The central bank will now allow yields to temporarily rise as high as 1 percent, while maintaining the target range of plus or minus 0.5 percent – and an official target of about zero. 

Although the BOJ claims this isn’t a move toward normalisation (i.e., lift-off from negative short rates), the market sees the new effective yield ceiling at 1 percent instead of the quasi-official 0.5 percent. This should tighten the interest-rate differential with the US and prevent the yen from over-weakening, helping slow imported inflation. 

This increased flexibility also hopes to make monetary easing more sustainable, while limiting government bond purchases. The BOJ has acknowledged that its inflation target of 2 percent, in a “sustainable and stable manner, supported by wages,” is closer to being achieved.

Corporate Japan changes its approach

Inflation woke up corporate Japan, too. The government has taken extraordinary measures to help companies of all sizes hike wages. 

For instance, March and September are now called “cost pass-through months.” Smaller companies are encouraged to pass on higher costs to their larger clients and to report any unfair negotiations. 

To pay for their wage hikes, companies must boost profitability. Price hikes, long shunned by companies afraid of losing market share in a deflationary environment, are now widely accepted – as the corporate Tankan survey charted in the next visualisation shows.

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Other moves by Japan’s largest companies are playing a major role. For instance, new criteria for the nation’s key equity index are encouraging companies to raise their price-to-book ratios and return on equity. The result? Along with increased dividends and stock buybacks, capital expenditure is rising, and this is expected to continue. 

According to Nikkei news, nominal capex is on the way to pass JPY 100 trillion, setting a new record.

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TSMC, Samsung and Intel drive a tech resurgence

Semiconductors are so important for global industry that some observers call them the “new oil.” Their importance was seen when the pandemic disrupted supply, leading to knock-on effects like halts to automobile production lines – and, of course, global inflation. 

Japan dominated semiconductors and the tech scene in the 1970s and 80s. But that golden age was ended by the Plaza Accord of 1985, the US-Japan Semiconductor Agreement of 1986, and the advent of the digital age from the 1990s onward. The loss of tech leadership coincided with Japan’s “lost decades.” 

Now, Japan is attracting domestic and foreign investment to cement its role in global semiconductor supply chains. Examples include investments by Taiwan’s TSMC in Kumamoto, South Korea’s Samsung in Yokohama, America’s Intel in Toyama and Micron in Hiroshima, and Belgium’s Imec in Hokkaido. Notable domestic investments include Renesas in Kofu, Kyocera in Kagoshima, and Nidec in Kawasaki.  

In conclusion, the inflation revolution is showing up in hard data, with nominal GDP approaching the Abenomics-era target of JPY 600 trillion. On the corporate side, fiscal 2022 revenue for major corporates improved by 11 percent, the fastest growth in over 30 years. And foreign investments are driving a restoration of Japan’s tech sector – even before developments in artificial intelligence that some observers say could nearly triple economic growth.⁵ 

Corporate Japan and government policymakers will be hoping to extend this boom.

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The Federal Reserve’s monetary policy balances a dual mandate, aiming for a 2 percent inflation target while supporting sustainable employment. The Fed’s steep tightening cycle was extended at the July policy meeting, which unveiled a 25-basis-point rate hike to contain inflation risks on the back of a resilient labour market. 

The next key data point for Fed watchers is the US non-farm payrolls (NFP) report, which will be released on Friday. This employment statistic is closely studied by economists, strategists and market participants and will likely influence the Fed’s next policy decision in September. 

To generate this prediction for the Friday NFP figure, we deployed univariate and multivariate forecasting techniques, using our partnership with Indicio Technologies.  

Considerations for developing the univariate and multivariate forecasts

Historic NFP data: This serves as the base data for the univariate model. The persistence of recent data points in the time series – the recency bias -- suggests an estimate close to 145,000. It also reflects a sequential decline from the print of 904,000 in February, 2022. 

This lower-than-consensus number does not reflect the economic resilience seen recently, especially in the last couple of quarters. (As the right-most columns of the next table show, the last three years have been far stronger on average than the past decade.) 

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When we construct a multivariate model, we incorporate factors influencing underlying economic shifts and driving employment trends. So, to create a better gauge of NFP, several other strongly correlated factors are considered:

Employment-related indicators: the unemployment rate, jobless claims, the labour force participation rate and private sector-employment data. These indicators provide a broader context for labour-market health. In particular, the high-frequency weekly initial jobless claims have a clear inverse relation with the NFP job creation, as the next chart shows.

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Economic indicators: GDP growth, inflation, consumer spending and business investment all influence the labour market. Higher GDP often correlates with positive non-farm payroll numbers:

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Industry-specific data: This includes manufacturing versus services trends, as well as specific industries or sectors that have a significant impact on the overall job market.

As the next chart shows, post-Covid, services sectors have driven payrolls growth much more than their counterparts in goods sectors. This trend was helped along by government transfers that stoked consumer spending on discretionary services.

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Next, breaking down the services segment, key contributions were made by professional and business services, transportation and warehousing, and the education and health sector.

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‍Monetary policy: Global and domestic economic shifts influence the Fed, and a restrictive or expansive Fed stance influences business sentiment and hiring intentions.

Monetary transmission from steep rate-tightening cycles adversely impacts NFP, typically with a two- to three-quarter lag, as this chart shows.

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The consumer confidence index: This indicator can provide insights into potential changes in consumer spending and hiring.

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Leading Economic Indicators: These include metrics like the purchasing managers' indices (PMI) and housing starts, which can help predict economic trends.

The deceleration seen in Services PMI (the employment index) suggests softening is ahead for NFP.

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Seasonal adjustments: Non-farm payrolls can exhibit seasonal patterns due to factors like holiday hiring or school-year cycles. As a result, seasonal adjustments are applied to help remove these effects and reveal underlying trends.

Sentiment analysis: Keeping a close tab on media reports, expert opinion and surveys helps gauge market sentiment and the expectations that impact job-market dynamics.

Statistical forecasting methods: Indicio utilises various statistical techniques including time-series analysis, regression and ARIMA. It considers 16 statistical models, such as VARX Lasso, HVAR, MIDAS , ANN and others (if a statistic fit is found) to arrive at a weighted forecast for non-farm payrolls.

The result of our forecast

As the next chart shows, we are predicting that non-farm payrolls will come in at 193,000 for July. That’s a tad lower than the consensus of 200,000 – and, in our view, not a deterrent for a Fed “pause” in September if CPI figures continue to show slowing inflation.

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The multiple explanatory variables analysed in this blog all make different contributions to the overall result. Our last chart shows how these various factors are a support or a drag when our prediction is compared to the previous NFP print (209,000).

In conclusion, our analysis suggests that the cyclical downtrend for NFP will continue. And if inflation figures continue to ease, we could well have reached the peak of this Fed rate cycle. This would be consistent with market expectations – which are currently pricing in only a 16 percent chance of another interest-rate hike in September. 

More about Macrobond x Indicio
The Macrobond community can now access Indicio’s technology through a direct API. And Indicio’s latest release allows Macrobond users to export outputs from their models and store them in Macrobond – using our front-end for visualisation purposes.

Request a Indicio demonstration and download our factsheet to learn how Indicio can allow you to rapidly build a wide range of sophisticated, statistically robust forecasts– with no coding expertise required.

UK CPI will be released tomorrow early morning, let's dig a little deeper. 

Why this print is important: Last week marked the US ‘soft landing’ outlook back on the table post the lower than expected US CPI release at 3%. 2 year UST yield dropped a sharp 35bps, and the market re-aligned towards one last rate hike by the Fed in July (against Fed’s own projected two steep hikes in 2023).

UK remains a different story so far: 13 consecutive rate hikes since 2021 from 0.1% to 5% on the back of elevated CPI prints, with headline still stubbornly higher than target. 

CPI internals for previous release (May’2023) powered by Macrobond charts:

• Chart 1 - May CPI at 8.7% saw headline Services inflation (7.3%) rising further while Goods inflation (9.7%) stayed stubborn
• Chart 2 - Positive MoM momentum (0.7% for overall CPI) and across categories in May, no price pressures ebbing (CPI Heatmap)
• Chart 3 - Headline prints have remained elevated tracking higher contribution from both cost push as well as demand pull (boost in services consumption) factors: Spike in gas prices within Housing inflation; 2. Higher rentals, 3. Higher food & beverages inflation, 4. Restaurant and Hotel services and 5. Clothing and footwear inflation

Expectations for the June data release: Estimate June CPI to be ~8.3% basis our multivariate forecast model using Indicio (Chart 4). Further CPI prints up to August likely to decelerate basis:

• BoE’s steep rate tightening cycle to impact consumption with a lag
• cost push factors post war gradually to abate
• some correction seen in House price sentiment 
• base effects

BoE policy implications: June estimate at 8.3% v/s target of 2% implies BoE has more ground to cover to contain inflation before taking a policy pause

The above story through our charts: 

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Chart 1: May CPI at 8.7% saw headline Services inflation (7.3%) rising further while Good inflation (9.7%) stayed stubborn

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‍Chart 2: Positive MoM momentum (0.7% for overall CPI) and across categories in May, no price pressures ebbin

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‍Chart 3: Headline prints have remained elevated tracking higher contribution from both cost push as well as demand pull (boost in services consumption) factors: Spike in gas prices within Housing inflation; 2. Higher rentals, 3. Higher food & beverages inflation, 4. Restaurant and Hotel services and 5. Clothing and footwear inflation

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Chart 4: June CPI print est at 8.3%, further softening sub 8% by September likely

Note: The Indicio model helps nowcast and merge various frequency data (daily natural gas prices, weekly gasoline pump prices, monthly wages etc).

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As some nations seek alternatives to the dollar, our visualisations explore how the global reserve currency is being displaced in some ways – and not at all in others.

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“Why can’t we do trade based on our own currencies?” Brazilian President Luiz Inácio Lula da Silva recently remarked in Shanghai.

Lula’s proclamation made headlines as it amplified an issue that is resonating with policy makers from Washington to Beijing and is increasingly of interest to central bankers and financial strategists: the US dollar’s overwhelming dominance in global trade. 

When Brazil exports soybeans to China, they are priced in dollars. (And China, like other dollar holders, tends to park the funds it receives in the US Treasury market – with its unrivalled depth and liquidity.)

This reflects the reach and staying power of the greenback’s post-WWII status as the world’s reserve currency. The prominent economist Barry Eichengreen, amongst others, argues that the US can run persistent current account and budget deficits more easily than any other nation. French Finance Minister (and later president) Valery Giscard d’Estaing described the situation as an “exorbitant privilege.” 

Since Russia’s invasion of Ukraine last year, the de-dollarisation debate has become more acute due to the power the US has to extend its geopolitical reach with sanctions. The SWIFT global payments system disconnected Russian banks, and using dollars to settle Russian oil trades became more problematic for buyers.

So is the dollar’s global role shrinking in real time? We examine three ways in which the greenback’s role is potentially under threat from rivals like the euro and yuan. 

Central bank reserves

Reliance on the dollar has been steadily declining by one measure: its share of global foreign-exchange reserves held by central banks. These institutions hold massive amounts of various currencies to ensure the flow of trade and support their nation’s own currency.

As our chart of IMF data shows, the dollar remains by far the main currency of choice, but its share has dropped to 58 percent from 70 percent over the past 20 years. 

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The euro’s share grew in the 2000s before retreating; it’s back at about 20 percent. 

The “other” category, including currencies from Australia, Canada, South Korea and the Scandinavian nations, is also gradually inching higher. IMF economists have posited that these currencies are considered as safe as the dollar, but offer higher returns than the greenback.

What about China’s yuan? Central bank holdings of the renminbi have been increasing, but from a tiny base, and now stand at 3 percent. 

Swap lines (which let central banks exchange one another’s currencies) are also worth watching. Bloomberg News recently reported that the use of Chinese yuan in foreign-exchange swaps underwent the second-largest quarterly surge at the end of March.  

China is keen to internationalise the use of its currency, but capital controls have stood in the way. The yuan cannot flow freely in and out of the country. 

However, there are offshore yuan markets in financial centres such as Hong Kong, and China has been working on an alternative to the SWIFT system to make it easier for other countries to use renminbi. How is it doing?

A “SWIFT” for the yuan?

The next chart tracks use of the CIPS (the Cross-border Interbank Payment System). This SWIFT-like system lets participants clear and settle trades in yuan. It’s used by Chinese companies and institutions, but international banks like HSBC and Standard Chartered are also involved. CIPS says it has 80 “direct participants” and 1,357 “indirect participants” based in more than 100 countries.

China introduced CIPS in 2015 after Russia was sanctioned by the US and EU following its annexation of Crimea, complicating the use of the dollar in Russian oil exports. 

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The value of CIPS receipts and payments in renminbi (or yuan) terms has been gradually rising, as the bars show; the number of transactions, as measured by the left-hand axis, has surpassed 1 million per quarter.

CIPS processed about USD 14 trillion in transactions in 2022, a 21 percent increase.

The second panel of our chart tracks the Renminbi Globalisation Index. The RGI, compiled by Standard Chartered, measures the overall growth in offshore yuan use. (Its methodology can be accessed here.) 

After declining in the first two years after CIPS was created, the RGI has steadily moved higher since 2018.

Back to SWIFT (otherwise known as the Society for Worldwide Interbank Financial Telecommunication). This Brussels-based payment network still dwarfs CIPS; it’s estimated to process more than USD 150 trillion in transactions per year. 

It’s still King Dollar on SWIFT

This chart tracks different currencies’ share of global SWIFT payments over time. By this metric, the greenback’s importance has barely budged.

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The dollar accounts for 40 percent of the value of transactions, about the same as a decade ago. The euro has occasionally challenged for the top spot, but has seen its proportion shrink of late. 

Starting from a low base, China’s renminbi grabbed an increasing share of SWIFT payments in the mid-2010s, but that trend has leveled off.

What about the Russian ruble, at least before the recent round of sanctions? In December 2021, SWIFT says the Russian currency was used in just 0.2 percent of payments processed.

Speaking of the ruble, a high-profile recent impasse shows how sticky the greenback is, even for nations as hostile to the US as Russia. 

Russia has long counted on India as a key market for its military equipment, and India is keen to import discounted Russian oil. However, New Delhi risks running afoul of US sanctions if it pays Moscow in dollars. And Russia has said it doesn’t want rupees. Pakistan faces a similar dilemma, and wants to pay in yuan, but Russian companies are reportedly not keen to accumulate Chinese currency that isn’t fully convertible.

“We need to use this money, but for this, these rupees must be transferred in another currency,” Russian Foreign Minister Sergei Lavrov said at a meeting of the Shanghai Cooperation Organization in Goa. “This is a problem.”

His remarks summarise the dilemma facing proponents of de-dollarisation. International trade naturally seeks a common unit of exchange. While the situation may change, the dollar has no obvious near-term alternative that can truly take on the currency’s unique role.