Key Highlights

• Bank of England should be wary of over-committing to cuts
• U.S. equity flows not aligning with inflation risk
• EM APAC the odd region out with China anchoring disinflation

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MPC members shouldn’t risk over-confidence on wage trends

EXHIBIT #1: WEEKLY NEW AND TOTAL JOB POSTINGS IN THE U.K.

_{Source: BNY, Macrobond}

Our take

The Bank of England is expected to cut by 25bp today, but heavy caveats are needed. Firstly, we believe dissents will remain, but potentially in both directions again as some Monetary Policy Committee members may see a case for a 50bp move as much as staying on hold. Growing slack in the labor market is undeniable, with high-frequency data highlighting both new and total job openings having fallen below pre-pandemic levels. However, whether this can translate into material weakness in pay settlements remains difficult to determine. The June meeting contained several references to the level of pay growth and pay awards, with numbers as high as 6.7% y/y in the retail and hospitality industry to 3–4% in negotiated settlements. These figures were cited as evidence that the economy was “on tack” for pay moderation, but in absolute terms the levels remain above the inflation target and warrant ongoing restraint.

Forward look

The U.K. economy remains the most stagflation-affected of European economies and the productivity challenges are well documented. Meanwhile, compared to the Eurozone the U.K. is fiscally constrained to increase public investment, and the latest reports suggest another major fiscal adjustment is due later in the year. The BoE may also be minded to lower rates in support of the fiscal adjustment process, but pushing real rates lower at a pace faster than the rate of wage growth easing risks prolonging stagflation, especially with the U.K.’s poor productivity record. Our flow data indicate a clear preference for EURGBP at present, even with the Continent’s trade and growth challenges. A more dovish-than-expected BoE outcome will continue to support EURGBP as the market will favor the “least stagflationary” economies in the developed world.

U.S. market not rewarding inflation hedges despite data and policymaker warnings

EXHIBIT #2: U.S. INLFATION-LINKED FLOWS VS. BREAKEVEN INFLATION RATE

_{Source: BNY, Bloomberg}

Our take

In the wake of the recent labor market data out of the U.S., more forceful Fed easing is back in the frame, and this has checked the dollar’s attempts to recover through the “U.S. exceptionalism” narrative. Even so, similar to the U.K., the pace of the slowdown in job creation may not be commensurate with the slowdown in wage growth and the knock-on impact on inflation. Furthermore, as we highlighted in this week’s Short Thoughts, “the still-evolving tariff region will prove stagflationary, both lowering growth and raising inflation. This is exactly what appears to be happening now.” Although nowhere near the highs seen earlier this year, throughout July there has been a noticeable pick-up in breakeven inflation rates, and it has been closer to a year since the market was willing to price in below-target inflation. When this did happen, in August 2024, it was due to a market panic regarding growth. However, the recovery in risk appetite has not extended to pricing in price risks: iFlow shows that inflation-related equity flows are registering their worst period of performance in over six months.

Forward look

The need to chase tech- and AI-related capex means that return profiles in most sectors are currently poor, so it may not be a case of market participants actively disregarding inflation risk. Nonetheless, we highlight that stagflationary economic episodes are seldom favorable for asset allocation due to the constraints it places on policy space. If inflation necessitates a delay in Fed easing, the dollar will rally, but this will also mean a more comprehensive tightening in financial conditions through the currency and rate channel beyond what is currently being priced in equities. If the capex and investment story begins to fade, equity reversals may happen very quickly and once again threaten the “U.S. exceptionalism” trade. On balance, a stronger dollar remains the most likely result, but as trade realigns the normal transmission channel through lower import prices may not function in the usual way. In the past, any form of risk premia was most easily reflected through the exchange rate; however, future episodes amid stagflation may require some burden sharing in other assets, and new tests of U.S. asset exceptionalism will arise.

Very limited signs of price recovery in China, constraining APAC policy space

EXHIBIT #3: CHINA PRODUCER AND CONSUMER GOODS INFLATION

_{Source: BNY, Macrobond}

Our take

EM APAC remains the only region where central banks have reason to worry about inflation undershooting targets. The latest Thai inflation print, at –0.7% y/y now puts the country in deeper price contraction compared to China. Yet, like many countries in the region, weakness on the external front is coming from tariff risk and the soft Chinese economy. For Thailand, whose balance of payments is materially dependent on Chinese tourism, the impact of weakening growth and income expectations in China is direct. For manufacturers across the region, the risk of Chinese producer prices continuing to decline and thus depressing prices elsewhere is an even bigger risk, especially with margin pressures now arising from U.S. tariffs. China’s producer and consumer goods output prices remain deeply negative (Exhibit #3). Even with the anti-involution campaign in full swing, it will take time for price stabilization domestically, and only after this takes place will regional benefits materialize.

Forward look

Stagflation in developed markets affects real returns and is not ideal for asset allocation. Through much of Q2, we highlighted that while there is very little prospect of the dollar being displaced as the world’s preeminent reserve currency, there were “safety” benefits to diversifying into savings-heavy currencies in APAC. Normally such flows are welcomed by central banks in the region, but with baseline inflation so low and domestic demand in no position to compensate for external headwinds, tolerance for currency strength remains limited. At best, adverse inflation differentials against APAC economies can help keep currency valuations stable in real terms while nominal exchange rates improve slowly. Until Chinese inflation reaches escape velocity, policy space in the region will be very limited. The current state in iFlow, where almost all APAC currencies are underheld and seen as funders, will remain the default positioning.

Bottom line

From public investment in services and defense in Europe to AI-based capital expenditure in the U.S. and beyond, productivity and competitiveness gains have been promised by governments and corporations alike. Yet, any associated improvements will take time and will be incremental. Meanwhile, vestiges of supply chain pressures, especially in labor, from recent years continue to hamper inflation-targeting. At the same time, fresh risks are emerging from global trade realignment, leaving central banks unable to prepare sufficiently accurate scenario analyses to respond. Consequently, we suspect that conviction levels are low in the supposed consensus view that rates can only go down and pressure affected currencies. The Bank of England will kick off what we expect to be a new run of cuts through August and September in Europe, but over-committing to easing risks policy error and prolonging stagflation.

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