Charts of the Week: Rising R-Star, ‘Last-Mile’ Disinflation, and a 2024 Oil Supply Deficit

Summary

• The Fed has r-star around 0.5% in real terms, but markets are pricing it around 2%. We think this could be a return to the pre-GFC ‘normal’.
• US disinflation could be entering its ‘last mile’ phase, implying slower price increases ahead.
• Asian trade data corroborates the recent pick-up in global manufacturing, but a lack of breadth in export growth concerns us.
• The oil market looks set for a supply deficit of 0.4mn b/d assuming OPEC does not unwind its production cuts.

Market Implications

• A higher r-star leaves room for yields to rise when growth and inflation risks are tilted to the upside – so we are short UST targeting a move to 4.4%.
• The Fed expects slower disinflation and will likely take a wait-and-see stance to higher MoM prints, making a March cut unlikely.
• If the lack of breadth persists, the cyclical recovery trade in KRW and TWD could unravel.
• We expect Brent to settle around $85/bbl by Q2 given the potential supply deficit.

Has the Fed Got R-Star Wrong?

Currently, the Fed has r-star around 0.5% in real terms, which means 2.5% in nominal terms assuming 2% inflation is the steady state. Yet markets are pricing a much higher r-star – 5y5y real rates are around 2%, making the nominal neutral rate around 4% (Chart 1).

But is that unusual? If you look at the 2010s, yes. It was much lower then. But it was not unusual pre-GFC.

Accordingly, as Bilal argues, r-star may simply be returning to a ‘normal’ level. And we will exceed that level when growth and inflation risks are tilted to the upside and term premia is in play. That is our current view and why we are short UST targeting a move to 4.4%.

‘Last Mile’ of US Disinflation Approaches

The precedent of the 1980s and 1990s suggests there is a slower ‘last mile’ phase of the disinflation process. We could be about to enter this last mile – that is, disinflation could be about to slow. This time, however, the last mile could still be faster than during the 1990s because of lower inflation inertia and a more efficient economy, even though unemployment is lower. Under plausible assumptions, Dominique argues disinflation could slow to about 70bp/year in 2024, compared with a disinflation pace of 1.3ppt/year in 2022-23.

Asia’s Exports Are on the Rise

Is the year-long global manufacturing recession over? You might think so given the S&P Global Manufacturing PMI recently rose to 50.0, the highest level since August 2022. Trade data from the early reporters in Asia (Korea, Taiwan, Vietnam) corroborates this pick-up in manufacturing. These economies typically lead the rest of EM (Chart 3).

However, growth is still concentrated in semiconductors and driven by shipments to the US. European and Chinese demand remains weak. This lack of breadth makes us cautious about celebrating too early.

Oil Market Deficit to Support Prices in 2024

Global oil demand is set to grow by 1.2mn b/d in 2024, led by growth of 1.3mn b/d in non-OECD countries and offset by a small decline in OECD nations. As Viresh argues, this will leave the oil market in a supply deficit of 0.4mn b/d assuming OPEC does not unwind its production cuts (Chart 4). We therefore expect Brent to settle around $85/bbl by Q2.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)