Between A Rock And A Hard Place

Between A Rock And A Hard Place
Reda Farran, CFA

4 months ago4 mins

What happened last week?


  • Inflation edged up slightly in July but by less than economists had expected.
  • Moody’s Investors Service downgraded the credit ratings of ten regional banks.


  • Italy announced an unexpected tax on banks’ windfall profits.
  • Long-term inflation expectations in the eurozone hit a 13-year high.
  • The UK economy delivered its strongest quarterly growth in over a year.


  • China’s trade plunged last month, dealing another blow to its economy.
  • Making matters worse, the country also slid into deflation in July.

What does all this mean?

New data out last week showed consumer prices in the US were 3.2% higher in July, compared to a year ago – a slight uptick from June’s 3% pace but slightly below economists’ forecasts of 3.3%. Core inflation, which strips out volatile food and energy prices, decelerated ever so slightly to 4.7% last month, which was in line with economists’ estimates. While still elevated, the measure has slowed nearly every month since peaking at 6.6% in September, and that could prompt the Federal Reserve (the Fed) to keep interest rates unchanged next month.

Moody’s Investors Service downgraded the credit ratings of ten regional US banks last week. Lenders’ balance sheets are looking worse and worse, as higher interest rates drive up their funding costs and erode the value of their assets. Those higher rates are also making it harder for commercial real estate borrowers to refinance their debts at a time when demand for office space is falling, resulting in increased loan losses for heavily exposed banks.

Adding to the list of worries facing bank investors, Italy’s government unexpectedly announced a 40% windfall tax on the profits the country's banks make off high interest rates, a move that erased roughly $10 billion from Italian lenders' market value. The government slightly watered down the proposal a day later, but the damage to investors' confidence had already been done.

The British economy grew by 0.2% in the second quarter from the one before, surpassing the Bank of England's forecast of a 0.1% expansion. This surge in growth, fueled by strong performances in manufacturing, construction, consumer spending, and business investment, will likely keep upward pressure on wages and prices, and may force the UK central bank to consider further rate hikes.

Exports have long been China’s economic spine, but with global demand slowing, things shipped out of the “world’s factory” have now dwindled for three straight months. And July’s figures, out last week, were particularly grim, showing a 14.5% drop (in dollar terms) compared to last year – that’s the steepest fall since Covid’s very early days in February 2020. Domestic demand isn’t faring any better either, with imports tumbling 12.4% – the steepest drop since a Covid wave hit China in January, and much bigger than the 5% fall forecast by economists.

Further highlighting China's sagging domestic demand, data out last week revealed the country sank into deflation in July. Consumer prices in the world’s second-biggest economy dropped 0.3% last month from a year earlier, marking the first decline since February 2021. Investors are hoping that the weak data will push the People’s Bank of China to introduce new monetary stimulus measures, like interest rate cuts. However, factors like a depreciating yuan and elevated debt levels in the economy are causing the central bank to tread carefully.

This week’s focus: US banks

Moody’s decision to downgrade the credit ratings of ten regional US banks on the back of deteriorating balance sheets is totally understandable. A recent analysis showed that US banks racked up nearly $19 billion in losses on bad loans in the second quarter of this year. That’s a 17% jump from the prior quarter and a 75% jump from the same time last year. Rising defaults from credit card and commercial real estate borrowers, particularly those with floating-rate loans, were a massive driver – and that’s hardly surprising considering the Fed raised interest rates from near zero to a 22-year high in a little over a year. But this might be just the tip of the iceberg: in the second quarter, US banks set aside an additional $21.5 billion to cover potential loan losses, more than they've socked away since the height of the pandemic crisis in mid-2020 and the third-most in a decade.

The week ahead

  • Monday: China foreign direct investment (July).
  • Tuesday: Japan economic growth (Q2), China retail sales and industrial production (July), UK labor market report (July), US retail sales (July). Earnings: Home Depot.
  • Wednesday: UK inflation (July), minutes from the Fed’s latest meeting. Earnings: Cisco.
  • Thursday: Japan trade balance (July). Earnings: Walmart, Applied Materials.
  • Friday: Japan inflation (July), UK retail sales (July). Earnings: Xpeng.


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