| Rafi Gozlan, Chief Economist at IBI Investment House
Global macro data indicate a recovery in global activity since the beginning of the year, after moderation throughout the second half of 2022.
The Global Purchasing Managers’ Index rose back above the 50 level in February, reflecting a return to the expansion of global activity after throughout the second half of 2022, it remained below 50 and reflected a slowdown in activity.
The return to expansion in activity is mainly supported by the acceleration of activity in the service sectors, compared to a moderation in the industrial sectors which reflects a return to more normal consumption patterns after the surge in demand for industrial products that characterized the Corona crisis.
Also, the improvement in global activity has been supported in recent months by the opening of the Chinese economy and the recovery of the Eurozone, against the background of the successful dealing with the energy crisis so far, including a sharp drop in gas prices in Europe in recent months, and this at the same time as support from the fiscal policy.
The same development also characterizes the American economy. Thus, the industrial index continued to move below 50 for the fourth month in a row, although in February the intensity of the decline moderated, and the development of the ratio between inventories and new orders reflects an expectation of stability around the current levels (still below 50) in the coming months as well.
On the other hand, expansion also continued in February and the index moved at the same level as in January of about 55. These levels are consistent with growth at the same rate recorded in the last quarter of 2022, of approximately 2.5%, although the growth mix is better, and reflects a stronger demand environment compared to the one that characterized the second half of 2022.
The main problem for the financial markets is that the improvement in activity is accompanied by a high inflation environment, with increasing signs of “sticky” inflation. After the data for the month of January in the US surprised upwards, with an emphasis on core inflation, this was the first estimate for inflation in the Eurozone in February that indicated higher than expected inflation while accelerating core inflation.
The general index moderated only slightly from 8.6% to 8.5%, supported by the drop in energy prices, while the basic index climbed from 5.3% to 5.6%, reflecting a horizontal increase in prices, and in particular an acceleration in service inflation.
In the US, although the price component in the ISM services index moderated in February as well, its level is still high and reflects high price pressures. In addition, the price component in the ISM industry index returned to levels above 50, reflecting a containment of the downward trend that until recently characterized commodity inflation.
This development is important because the decrease in commodity inflation is what drove the decrease in inflation in the last quarter-two in the US, so that the reduction in it, when in the background the inflation of services is moving at a high rate, will translate (similar to January) into a higher inflation environment, and this has already been reflected in a rapid increase in expectations to inflation.
As long as this trend continues, when in the background the American labor market is showing strength and the financial conditions are favorable, this is a mix that will lead to a high inflation environment that will translate into a higher increase in Although Fed spokesmen have so far sent reassuring messages regarding the rate of interest rate increases, and most of them tend to continue with increases of 25 basis points and not back to 50, but if inflation continues to surprise upward, a higher increase cannot be ruled out, although the threshold for this is relatively high.
In any case, the market is currently pricing in between 3 and 4 additional interest rate increases of 25 bps, and as long as financial conditions continue to hover around the current levels, the risk in this pricing continues to tend upwards in our estimation. Also, the higher than expected increase in inflation in the Eurozone, on A background of recovery in activity increases the probability that the ECB will raise the rate by 50 basis points not only in March but also in May.
After a prolonged period in which there was a downward trend in inflation expectations in the bond market, the latest inflation data, alongside the recovery in activity, led to a renewed increase in inflation expectations in the US and the Eurozone.
The majority of the increase is indeed focused on the short-medium term, but as the high inflation environment continues, the risk of gliding in expectations for the long term will increase, and the meaning will be a more “hawkish” policy on the part of the leading central banks.
In the local market, the rise in inflation expectations has increased recently and this is against the background of the higher than expected at the same time as the inflationary effects resulting from the devaluation of the exchange rate of the, a trend that will increase as long as the legislation to weaken the judicial system is not stopped.
In the public sector, which was signed last week, it is expected to lead to a certain increase in inflation, in terms of the improvement in income, but at first glance it does not seem unusual in terms of the annual rate of increase, although it is premature to estimate the second-order effect on wages in the private sector.
In this aspect, the wage data for the last quarter of 2022 did indeed indicate a certain moderation in the rate of wage increase in the private sector to about 4.5%, but the relevant figure in our estimation will be that of the first quarter of 2023, as it will illustrate the degree of compensation that will be received for the high increase in inflation in the last year , so that against the background of the tight labor market it is reasonable to expect a renewed acceleration in the rate of wage growth.
In our estimation, the latest developments in the world and the stabilization of the shekel’s exchange rate at current levels will lead to inflation of 4%-3.5% in the coming year. The increase in local inflation expectations did not stop in the short-medium term for maturity, but flowed into the long term as well, and they are close to 3%, and this is a problematic development for the Bank of Israel, since this development occurred even though the most recent interest rate increase was higher than expected.
Also, the high correlation of local basic inflation with that of the Eurozone, which as mentioned has accelerated recently, including the higher than expected inflation environment in the world and in Israel, are expected to lead to an increase in the interest rate to 5.25%-5% during the first half of the year, and the risk to this forecast tends upwards.
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