The numbers for the week - 31st January 2022

Markets last week

Market movements were dominated by the meeting of the US Federal Reserve (Fed) and its communication on Wednesday. Investors who anticipated a more dovish message or balanced delivery were disappointed.

Fed Chair Jay Powell made it very clear that the Fed is focusing on inflation above anything else and is willing to use all the tools at its disposal to stamp it out. Giving the strongest hint yet that the Fed Funds rate would rise at the meeting in March, concomitant with the end of asset purchases (quantitative easing – QE), Powell also talked about reversing the QE process, i.e. selling assets at some point this year. The combination of these policies was probably more than many market participants had been expecting and caused a massive intra-day move in the US equity market on Wednesday as well as significant follow-through later.

The equity correction was accompanied by a bond correction, a stronger US dollar and a flattening of the US yield curve (a lowering of the yield differential between the 2-year and 10-year US treasury bond yields) to 60 bps from 75 bps recently. Long-term inflation expectations have not changed much but bond yields have risen during this volatility, which is rather unusual and indicates less support for fixed interest investments through difficult periods. The interest rate backdrop has continued to boost cyclical sectors like energy and financials, extending the sector rotation we have been seeing this year.

The ongoing Ukraine stand-off is again helping oil prices, but other commodities have corrected in line with the Fed’s hawkish language. Gold fell below US$1,800 again.

Economic data have taken a back seat amid these policy-driven markets, but economic surveys have generally been softer whilst inflation gauges are still trending upward.

At the end of the week, equities were still down for the fourth week in US dollars (although they eked out a small gain in sterling) with huge day-to-day volatility. US indices rose sharply on Friday when other markets were closed. Emerging markets, European equities and small companies did the worst, with energy again the strongest sector but surprisingly technology rising as well but industrials and materials among the weakest. Government bond yields continued their upward ride, in particular gilt yields anticipating a hawkish tone from the Bank of England later this week. The US dollar rose to its highest since July 2020.

The week ahead

Wednesday: US ISM manufacturing PMI

Our thoughts: the ISM (Institute for Supply Management) provides a very detailed survey with the manufacturing PMI, going down into new orders, inventories, backlogs, employment, prices paid, etc. This gives an excellent picture of the state of various manufacturing industries in the US and is the opportunity to check on supply chains and potential bottleneck resolutions. After Q4 when most US economic growth came from the rebuilding of inventories, it will be interesting to note whether that trend is still ongoing, whether the expectation of higher interest rates has slowed any activity, whether prices are still soaring and employment is still buoyant.

Thursday: Bank of England MPC meeting

Our thoughts: the Bank of England’s MPC (Monetary Policy Committee) will deliver its decision on interest rates and asset purchases. This is an eagerly awaited meeting and after the Fed’s hawkish communications last week, as the BoE was the first major central bank to hike rates. The MPC is expected to raise its Bank Rate from 0.25% to 0.50% but not change its gilt purchase target from the current £875bn and its corporate bond purchases target from the current £20bn. The decision is important, but also the vote details and any potential change in policy to asset purchases and to future rate movements.

Friday: US employment report for December

Our thoughts: inflation and employment are the twin engines of the hawkish Fed policy. Inflation is driving expected rate hikes, but only because the US economy is very close to full employment. Changes to the job market will therefore be followed very closely. Non-farm payrolls are estimated to have risen by another 170K, with positive revisions for previous months, and the unemployment rate is supposed to have remained at its current low reading of 3.9% with little change to the labour force participation rate of 61.9%. Average hourly earnings will further colour the picture for US inflation.

Markets for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Powell’s hawkish message received by markets

The week was dominated by the market communication from the US Federal Reserve (Fed). Fed Chair Jay Powell noted that the current US labour market looked close to maximum employment and that the labour force remains subdued, due to structural factors like retirements as well as health concerns. He also noted that wages were rising and sticky.

Powell is not expecting much supply chain relief this year and sees a short impact of Omicron on Q1 growth. Also, labour markets and corporate balance sheets are not vulnerable to higher interest rates or lower asset prices. He repeated many times that this is not 2015: inflation is too high, growth is substantially above trend and labour markets are very tight.

Powell then went on to say that the Fed was ready to raise rates in March and didn’t rule out moving at every meeting to tackle the highest inflation in a generation: “This is going to be a year in which we move steadily away from the highly accommodative monetary policy we’ve put in place”. As a result, markets increased their pricing of Fed hikes to a 94% probability of five ¼% upward moves in 2022, which was higher than before his speech.

Regarding the Fed’s balance sheet run-off, he confirmed that it would not start until after rates are already rising, but they had not yet discussed how to do it. He said the central bank would need to be “nimble”. He acknowledged that the Fed would react to events and data, rather than necessarily having a pre-set course for the duration of the rate cycle.

United States

Surveys look less buoyant, but Q4 growth and housing are strong while inflation keeps rising

Surveys: the Markit manufacturing PMI fell from 57.7 to 55.0 but the services PMI collapsed from 57.6 to 50.9 and the Chicago Fed National Activity Index slumped from 0.44 to -0.15, both below estimates. The Richmond Fed manufacturing index fell from 16 to 8. The Kansas City Fed manufacturing activity index rose from 22 to 24.

The US Conference Board consumer confidence index was down from 115.2 to 113.8, but with a difference between the present situation rising from 144.8 to 148.2 and expectations falling from 95.4 to 90.8. The percent expecting higher income dropped to 16.7% from its recent 20% peak last July and remains well below its pre-COVID-19 peak of 24.9% in July 2019. The other main confidence index, the University of Michigan sentiment index also fell from 68.8 to 67.2, with current conditions down from 73.2 to 72.0 and expectations down from 65.9 to 64.1.

Housing: US housing is still on fire but different sectors are mixed. The FHFA house price index was up 1.1% in November and the Case-Shiller index 18.81% year-on-year barely less than the 19.03% the previous month. The 20-city index rose 18.29% year-on-year with a monthly increase of 1.18%.

New home sales for December were very strong, up 11.9% for the month, following another similar month up 11.7%. Pending home sales fell sharply, down 3.8% in December, following a drop of 2.3% the prior month. MBA mortgage applications slumped 7.1% during the week, down from a positive 2.3% before.

Inventories: US retail inventories were up 4.4% in December, indicating some improvement in the supply chain. Wholesale inventories increased 2.1% on the month, following a previous 1.7% rise.

Employment: jobless claims continue to be affected by Omicron, with a drop in the initial claims from 290K to 260K but a rise in continuing claims from 1624K to 1675K.

Inflation: the PCE (personal consumption expenditures) deflator rose from 5.7% to 5.8% and the PCE core deflator (ex food and energy, which is the gauge used by the US Federal Reserve) rose from 4.7% to 4.9%, above estimates. The University of Michigan 1-year inflation expectation remained at 4.9% and the 5-10-year inflation was stable at 3.1%. The employment cost index during Q4 was a little easier at 1.0% vs. 1.3% the previous quarter.

Growth: Q4 GDP beat estimates with an annualised rate of 6.9%, but also a higher GDP Price Index at 6.9% vs. 6.0% expected. The core PCE (Personal Consumption Expenditures) rose from 4.6% to 4.9% for the quarter. Personal income rose 0.3% in December, but personal spending fell 0.6%.

Industry: durable goods orders had a negative month, down -0.9% in December vs. a rise of 3.2% the previous month, although ex transportation the orders were up 0.4%. Capital goods shipments non-defence ex aircraft rose 1.3%.

United Kingdom

Mixed surveys

Public finances: public finances were as expected, with the Public Sector Net Borrowing Requirement at £16.1bn but the previous month had a large downward revision, adding to a large borrowing undershoot for the year.

Surveys: the manufacturing PMI fell from 57.9 to 56.9 and services from 53.6 to 53.3.

The CBI Retailing series showed a significant improvement, with the total distribution total reported sales up from 12 to 39 and the retailing reported sale up from 8 to 28. The CBI Trend series was more mixed, with the total orders flat at 24, selling prices rising from 62 to 66 but business optimism slumping from +2 to -9.

Europe

Stable surveys

Surveys: the eurozone manufacturing PMI edged up from 58.0 to 59.0 but services fell from 53.1 to 51.2. The IFO business climate survey in Germany was up from 94.8 to 95.7, with the current assessment down from 96.9 to 96.1 but expectations climbing from 92.7 to 95.2. The GfK consumer confidence survey for Germany was a little higher at -6.7 vs. -6.9. French consumer confidence fell a smidge from 100 to 99. Eurozone economic confidence fell from 113.8 to 112.7, below estimates; industrial confidence was down from 14.6 to 13.9; services confidence from 10.9 to 9.1; and consumer confidence was unchanged at -8.5.

Money supply: M3 money supply in the eurozone grew less in December, up 6.9% year-on-year from 7.4% the prior month.

Inflation: the German import price index stopped its relentless rise, up 24.0% in December from 24.7% previously.

Consumer: French consumer spending rose 0.2% in December compared to 0.9% the previous month.

China/India/Japan/Asia

Is Chinese growth slower?

China: industrial profits fell, now up only 4.2% year-on-year in December vs. 9% the previous month. The official CFLP (China Federation of Logistics and Purchasing) manufacturing PMI moved from 50.3 to 50.1, the non-manufacturing PMI from 52.7 to 51.1 and the unofficial Caixin manufacturing PMI from 50.9 to 49.1, the worst level in almost two years.

Japan: the PPI (producer price index) for services was unchanged at 1.1% year-on-year. The Leading Index CI was a smidge higher at 103.2 vs 103.0 whereas the Coincident Index CI eased from 93.6 to 92.8. The consumer confidence index fell from 39.1 to 36.7. Industrial production fell 1% in December for a year-on-year growth of 2.7% compared to 5.1% previously. Retail sales fell 1% in December for a year-on-year growth of 1.4%. Housing starts in December were up 4.2% year-on-year, up from 3.7% before but below estimates.

Oil/Commodities/Emerging Markets

The ongoing Ukraine stand-off is again boosting oil prices with Brent finishing the week above US$90/bbl. Other commodities have corrected in line with the Fed’s hawkish language. Gold fell below US$1,800/oz again due to higher interest rate expectations.