The numbers for the week – 01 Aug 2022
Markets last week
The US fell into what is popularly known as a ‘technical recession’ (two consecutive down quarters) after Q2 (quarter two) GDP growth was negative at -0.9% following an also negative Q1 (quarter one) at -1.6%. It is of course not what people understand when they speak about a recession, since US unemployment is still near all-time lows, but it shows that growth this year will be hard to come by, in the US or elsewhere. Indeed, surveys in most countries last week showed a downward path. Many economic statistics were markedly weaker, whether consumer confidence, retail sales, home sales, housing starts or mortgage approvals. With the exception of a bullish surprise on eurozone growth for Q2 (mostly driven by tourism in southern Europe), only employment data continues to be strong everywhere (US, Europe, Japan), highlighting that the world’s central banks have a difficult road ahead in trying to stamp out inflation.
Indeed, the most important central bank, the US Federal Reserve (Fed), announced another 75 bp hike, taking Fed funds rates to 2.25%-2.50%. Interest rate markets are now pricing in a more benign hiking cycle than the Fed’s own forecasts in June (which were not updated last week). Investors are betting that Fed funds rates will peak around 3.3% this year before the Fed starts cutting modestly in 2023, whereas the Fed in June projected rates at 3.4% at year-end rising to 3.8% in December 2023. Indeed, the US 10-year treasury bond yield has fallen 0.8% from its peak a month-and-a-half ago in the expectation of a change in Fed policy.
Corporate earnings announcements have moved more than each company’s shares, as market participants have extrapolated the macro-economic background from their comments. In the US, downward earnings guidance from Walmart led the market to downgrade discretionary spending sectors in favour of consumer staples. On the other hand, global giants Apple and Amazon boosted the tech sector with their profit reports. The earnings season has also shown companies in the US, Europe and Japan with reduced profit growth. Interestingly, top-line revenue growth in the US, at about 9% year-on-year, is roughly in line with inflation. In Europe, at 12%, it is beating price rises, but in Japan at 9% with 2% inflation, companies have been delivering better real growth.
July had the best US equity returns since November 2020, when COVID-19 vaccines were announced. US shares are now more than 12% above their 16 June low. Bond markets also had the best month in over a year.
At the end of the week, government bond yields fell by 10-20 bps, with eurozone yields dropping the most. The US yield curve remains inverted, with the two-year yield 23 bps above the 10-year yield, still pointing to a recession or slowdown. Equities did well but with significant differences by market. US shares led and Asian markets lagged. The strongest sectors for the week were energy, utilities, materials, industrials and technology, with healthcare moving the least. The US dollar corrected, with the Japanese yen and sterling bouncing back from their weak streak. Oil prices rebounded and copper was very strong. Gold prices recovered from the US$1,700 level.
The week ahead
Monday: ISM manufacturing PMI
Our thoughts: it is now clear that growth is slowing in most countries. The US, as usual, has a greater impact on the rest of the world and on markets, so the extent of the downturn in the US has to be analysed. The ISM (Institute for Supply Management) publishes the manufacturing PMI on Monday and the services PMI on Wednesday. Both will matter to investors, but the manufacturing PMI is more instructive since many parts of the manufacturing sector derive their growth from one another in a way that services businesses don’t. The manufacturing index is expected to fall somewhat, but the details are important: new orders, employment, prices paid, inventories and backlog. Where the slowdown is coming from will have an impact on different markets.
Thursday: Bank of England Monetary Policy Committee
Our thoughts: the MPC (Monetary Policy Committee) of the Bank of England (BoE) is meeting again this week and is widely expected to take a bolder step in raising rates, hiking 50 bps to 1.75%. Unlike the US Federal Reserve (Fed), the MPC does not provide as much of a running commentary on its decision process and particularly future rate moves, but the number of MPC members who vote for or against the hike, will be a signal of the possible direction ahead. The BoE’s forecasts should also be revised and it will be interesting to note whether double-digit inflation projections will be maintained or even raised. Against the political backdrop with major discussions on whether one policy or another will lead to a recession or more inflation, the BoE’s growth forecast will be scrutinised carefully.
Friday: US employment data for July
Our thoughts: once again, can the US jobs market keep defying gravity as the economy slows down? New job creation should be affected by higher interest rates and the weaker economy, but employment is a lagging indicator and there are still many more job openings than jobseekers, so denting the jobs market is a tall order for the Fed. The last non-farm payrolls added 372K new jobs, a level which, if continued, would render the Fed’s inflation fight void, so the question is by how much will payrolls reduce? The sectors where jobs are created will also matter (services or manufacturing), while the labour force participation rate (are more workers coming out of inactivity?) and the average hourly earnings will be important for markets.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed communications interpreted by markets as signifying a future softening of the tightening policy
A momentous Fed meeting last week drove markets to assume a future softening of monetary policy, although it is hard to read this interpretation into the statement made by Fed Chair Jay Powell. The Fed hiked rates by 75 bps to a range of 2.25% to 2.5% and said they anticipate ‘ongoing increases’. Powell said the Fed will press on with tightening with more flexibility on coming moves amid signs of a broadening economic slowdown. He did not provide the specific guidance he gave at the June meeting, though he didn’t rule out another large move.
“While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data,” Powell said. “The labour market is extremely tight, and inflation is much too high. We do see that there are two-sided risks. There would be the risk of doing too much and imposing more of a downturn on the economy than was necessary, but the risk of doing too little and leaving the economy with this entrenched inflation – it only raises the cost.”
On Friday, Atlanta Fed President Raphael Bostic said that the US was not in a recession and that the Fed needed to address the high levels of inflation. “I’m convinced we are going to have to do more in terms of interest-rate moves. We are going to get a lot of data in the next two months before our next meeting and that will give us a good indication of what the right course of action is likely to be.”
The US$280bn Chips and Science Act was passed by Congress, providing support for the US semi-conductor industry.
Second negative quarter for growth, weakening surveys, falling housing market but steady employment
Surveys: US surveys are still weakening. The Chicago Fed National Activity Index was revised down for May and remained at the same level in June (-0.19). The Dallas Fed Manufacturing Activity index fell from -17.7 to -22.6.
The Conference Board consumer confidence survey dropped again, from 98.4 to 95.7, a low since early 2021, whereas the Richmond Fed manufacturing index unexpectedly rose from -11 to 0. The Kansas City Fed Manufacturing Activity index edged up from 12 to 13, against expectations of a fall.
The MNI (Market News International) Chicago PMI (also known as Chicago business barometer) slumped from 56.0 to 52.1, below estimates.
Housing: clearly slowing down. New home sales slumped 8.1% in June and MBA mortgage applications fell 1.8% last week. Mortgage applications have now dropped 25% year to date. The Case Shiller house price index for May eased to 19.75% year-on-year gain vs. 20.64% whereas the Federal Housing Finance Agency house price index was up 1.4% in May.
Industry: durable goods orders rose 1.9% in June, but only 0.3% ex transportation, wholesale inventories rose 1.9% and retail inventories 2%.
Growth: Q2 GDP was negative, -0.9% (annualised), after a negative Q1 at -1.6%, although the drop was driven by weak residential investment and a correction in inventories whilst personal consumption rose 1.0% and the trade deficit shrank.
Employment: initial jobless claims remained within the same zone, at 256K, vs. 261K the previous week, revised up from 251K. Continuing claims corrected somewhat from the previous week’s surge at 1359K vs. 1384K.
Inflation: the all-important employment cost index for Q2 rose 1.3%, vs. 1.4% the previous quarter. The GDP price index rose 8.7% (annualised) during the quarter, up from 8.2%, although the core PCE (personal consumption expenditures) for the quarter fell from 5.2% to 4.4%.
The PCE (personal consumption expenditures) deflator for June rose from 8.3% to 8.8% (annualised) with the PCE core deflator also up from 4.7% to 4.8%.
Consumer: personal income in June increased 0.6%, as in the prior month, and personal spending surged 1.1%, up from 0.3%.
Weaker surveys throughout
Surveys: the CBI Trends series was generally worse, with total orders down from 18 to 8, selling prices down from 58 to 48 but business optimism up from -34 to -21.
The CBI distribution surveys were weak. Total distribution reported sales fell from +1 to -12 whereas retailing reported sales edged up from -5 to -4.
The Lloyds business barometer fell from 28 to 25.
Inflation: the BRC shop price index rose from 3.1% to 4.4% in July.
Credit: net consumer credit grew from £0.9bn to £1.8bn in June with net lending secured on dwellings falling from £8.0bn to £5.3bn and mortgage approvals a little lighter at 63.7K vs. 65.7K.
Money supply: M4 money supply fell 0.3% in June taking the year-on-year growth from 5.1% to 4.1%.
Surging inflation, falling surveys contrast with surprisingly strong Q2 growth
Surveys: the German IFO (Institut für Wirtschaftsforschung) business confidence survey deteriorated to the worst level since the early months of the pandemic. The expectations fell to 80.3 from 85.8. The index of current conditions also dropped from 99.3 to 97.7 and business climate fell from 92.3 to 88.6. The IFO President said that Germany is on the brink of a recession with high energy prices and the threat of gas shortages weighing on the economy. French consumer confidence fell from 82 to 80.
Eurozone economic confidence slumped from 103.5, revised down from 104.0, to 99.0, the lowest level since the worst of the COVID-19 pandemic. Industrial confidence fell from 7.0 to 3.5, services confidence from 14.1 to 10.5 whilst consumer confidence remained at a low -27.
Money supply: remained steady, with M3 at 5.7% year-on-year in June, vs. 5.8% previously.
Inflation: French PPI (producer price index) was almost unchanged at a high 27.0%. The eurozone CPI (consumer price index) for July surged further to 8.9% from 8.6% with the core CPI also higher at 4.0% vs. 3.7%.
Growth: GDP for Q2 in the eurozone surprised on the upside by growing 0.7% (4.0% annualised) vs. 0.5% the previous quarter. The bullish surprise came mostly from Spain, Italy and France and was particularly driven by high tourist receipts.
Employment: German unemployment in July increased by 48K, more than estimates but down from 132K the prior month. The unemployment claims rate edged up from 5.3% to 5.4%.
Japan slowing down whilst Chinese manufacturing slumps
China: industrial profits rose 0.8% year-on-year in June, up from -6.5% the previous month. The official China Federation of Logistics and Purchasing manufacturing purchasing managers index (PMI) fell below 50, indicating contraction, down from 50.2 to 49.0, the official non-manufacturing PMI also fell from 54.7 to 53.8 and the unofficial Caixin manufacturing PMI was less bearish, down to 50.4 from 51.7.
Foreign direct investment was almost unchanged, up 17.4% in June year-on-year.
Japan: the PPI for services stood at 2.0% in June, vs. 1.9% in May, once again highlighting how little inflation there is in Japan. The consumer confidence index fell from 32.1 to 30.2. Housing starts in June fell 2.2% year-on-year. The jobless rate stayed at 2.6% but the job-to-applicant ratio rose from 1.24 to 1.27. Retail sales fell 1.4% in June whereas industrial production surged 8.9%, following a heavily negative month. Vehicle sales were less depressed, down 13.4% year-on-year in July, vs. -15.8% previously.
Commodities bounce back
Russia is once again sharply reducing the flow of gas to Germany, with Nordstream cut to about 20% of its capacity, which boosted natural gas prices in Europe. A key shipping hub in the United Arab Emirates was disrupted by flooding, stopping shipments of crude. Oil prices were well supported, with Brent topping US$110/bbl again. Copper continued to rise and gold rebounded from the US$1,700 level.