A Double-Digit Nightmare

This week was certainly a busy one, especially on the economic front. The week kicked off with disappointing economic data out of China, which prompted the country’s central bank to cut two lending rates in a move that many economists described as pointless. In the UK, the inflation rate hit double digits for the first time in more than four decades which, in turn, caused real wages to collapse. In Europe, power prices hit another record high, fueling further inflation in the region. Walmart reported results that were better than feared, sending shares in the world's biggest retailer higher. Finally, new data showed that hedge funds have turned bearish on the dollar. Find out why.

Macro

Data out on Monday showed China’s economic recovery unexpectedly weakened in July, as fresh Covid outbreaks across the country weighed on consumer and business spending. Industrial production rose 3.8% from a year ago – lower than June’s 3.9% and missing economists’ forecast of a 4.6% increase. Retail sales, meanwhile, rose only 2.7% year on year in July – significantly below the 5% increase economists were predicting.

The weaker than expected economic data spurred China’s central bank to unexpectedly cut both one-year and seven-day lending rates by 10 basis points. But many economists are skeptical, saying the rate cut would have little impact since Covid controls have made households and businesses reluctant to borrow in the first place. In fact, new credit in July increased at the slowest pace since at least 2017. All in all, slowing growth in China could spill over to the global economy considering the country’s outsized role in driving economic growth.

Moving on to the UK, data out on Tuesday showed real wages fell the most in at least 21 years during the second quarter. Inflation-adjusted earnings, excluding bonuses, were 3% lower in the second quarter than a year earlier – the biggest drop since records began in 2001. The figures highlight the financial difficulties facing households – even before energy bills sharply rise again in October. The data isn’t the best news for the UK economy, and is only set to increase recession fears as falling real wages combined with soaring energy bills dent consumer spending – the biggest driver of the British economy.

It’s important to note that real wages in the UK are falling because pay growth is being dwarfed by consumer prices rising at a much faster rate. And this week we got further proof of that: new data out on Wednesday showed the UK inflation rate hit double digits for the first time in more than four decades. Consumer prices increased by a more-than-expected 10.1% in July from a year ago, driven by higher food prices, which increased by 12.7%. The data will most likely push the Bank of England – which expects the inflation rate to rise to more than 13% in the final quarter of this year – to stick to its plan of aggressive rate hikes.

Moving on to the dollar, investor sentiment toward the greenback seems to be flipping. New data out this week showed that hedge funds have turned bearish on the dollar for the first time in a year. The bars in the graph below show how hedge funds are collectively positioned in eight different futures contracts linked to the dollar versus eight other major currencies. A positive number basically means hedge funds are betting that the greenback will rise in value. A negative number indicates the opposite.

The latest data shows that after having been bullish on the dollar for the past year, hedge funds collectively flipped to a short position last week, essentially betting that the greenback’s impressive rally over the past 15 months is coming to end. And there are early signs that that’s happening: the Bloomberg Dollar Spot Index (the black line above) – which tracks the value of the dollar relative to a basket of 10 leading global currencies – has fallen more than 3% from an all-time high in July after surging more than 14% in the year before that.

Key to this whole rise and fall: expectations about interest rate moves from the Fed. See, the shift in hedge fund sentiment toward the dollar comes as investors begin to bet that the Fed will slow down the pace of rate hikes it’s using to try to lower the country’s high inflation rate. Data out last week showed US inflation decelerated in July by more than expected, pushing traders to reduce the odds that the Fed will hike rates next month by as much as it did last month (75 basis points).

The prospect of a looming recession, meanwhile, is pushing some traders to bet that the Fed will be forced to cut rates next year. Higher interest rates make the dollar more appealing to international savers and investors, but lower interest rates have the opposite effect, which could explain why sentiment toward the dollar is beginning to turn.

Stocks

Shares in Walmart rose 5% after the world's largest retailer reported second-quarter earnings and revenue that both topped analysts’ estimates. It's important to put those results in context though, considering that the firm issued its second profit warning in 10 weeks last month. But thankfully for the retailing giant, things didn’t turn out as bad as expected due to strong back-to-school sales, lower fuel prices, and more buying by wealthier customers seeking bargains. On that last point: Walmart is wooing more middle- and higher-income customers who are increasingly turning to the discounter for cheaper food (and other essentials) amid soaring inflation.

To top things off, Walmart forecast that its earnings this year won’t decline as much as it expected three weeks ago when it issued a profit warning. That has positive read-throughs not only to other big retailers, but also to the broader economy considering that Walmart’s customer base looks a lot like the US population and is an epitome of their spending habits.

Commodities

Another week, another record, but not exactly a good one: European power prices jumped to a fresh record high at the start of the week, deepening the energy crunch that’s threatening to plunge the bloc into recession. German next-year electricity rates hit €540 a megawatt-hour on the European Energy Exchange. That’s six times higher than what it was this time last year, with the price more than doubling in the past two months alone.

The higher prices are being driven by concerns over whether Europe’s tight gas supplies will be able to generate enough electricity this winter. Making matters worse, France’s nuclear capacity is extremely low, denting the possibility of power exports in the months ahead. All in all, soaring energy prices are feeding through to household bills and are increasing the cost of nearly everything. That, in turn, is fueling inflation across Europe, with consumer-price increases hitting double-digit territory in many of the region’s economies.

Next week

Second-quarter earnings season continues to wind down but there are still a few big names reporting next week including lockdown favorites Zoom and Peloton. They’ll be joined by Chinese EV maker Xpeng, software firm Snowflake, and chip giant Nvidia, which already previewed its poor results last week. The economic calendar is a bit light, but we have PMIs coming out of the UK, eurozone, and US on Tuesday.