Markets last week
This was the week when markets reacted fully to the UK mini-budget and when the Bank of England (BoE) stepped in to stop potentially negative financial consequences. The Financial Policy Committee (FPC) of the BoE (which deals with financial stability issues), rather than the Monetary Policy Committee (which sets interest rates) started a programme of £65bn of gilt purchases. For the time being, the intervention appears to have been successful, as gilt yields fell from their peak of nearly 4.50% on the 10-year maturity to 4.09% on Friday and sterling rallied from its previous drop by almost 3% vs the US dollar but also 1.7% vs the euro.
The experience of the Bank of Japan recently buying Japanese yen in the foreign exchange market, with the currency now lower than it was at the time, shows that the FPC’s job may be more complicated than first reactions would seem to indicate. Also, UK sovereign bond ratings are due to be reviewed on 21 October by the main rating agencies and the recent policy changes suggest that rating downgrades are possible. This could have the effect of removing gilts from the investible universe for some central bank investors at a time when foreigners hold 30% of the gilt market.
Comments by US Federal Reserve (the Fed) officials all pointed in the direction of uninterrupted monetary tightening. This was reinforced by falling jobless claims, to the lowest level since April, at a time when employment should be going the other way to reduce inflation.
The US dollar clipped its massive upward streak in the last few days, making commodity prices cheaper in European currencies, but no-one is expecting that this represents a change of trend for the greenback.
Equities were buffeted by the rate and currency moves, and the fiscal and monetary policy uncertainty resulting from the turmoil. In addition, the largest company, Apple, suffered analyst downgrades and led the technology sector down.
Friday also marked the end of the 3rd quarter, the third consecutive quarter where both bonds and equities have been negative. This is the first time since 1976 where three quarters in a row have been down for both markets.
The week was highly negative for shares, with UK small caps, US and Far Eastern markets doing worst and the FTSE 100 being most defensive. Unsurprisingly, given the FTSE’s return, energy and materials were the only positive sectors, whereas utilities, real estate and technology did worst.
Government bond yields were still up, despite the intervention, with 10-year gilts up 27 bps and US treasury bonds up 14 bps. The pound recovered against the US dollar but also the euro.
The week ahead
Monday: US ISM manufacturing PMI (and services PMI on Wednesday)
Our thoughts: the US economy seems to be more resilient than expected, with jobs still being created as opposed to shed, as well as industrial orders and personal income rising. How long can growth withstand the Fed’s tightening and the housing market fall? Surveys normally give us that perspective ahead and none is more important than the ISM (Institute for Supply Management) with its manufacturing and services versions and a wealth of details on new orders, inventories, prices, and employment. So far, none of the readings from this survey indicate a full recession forecast. Will that change and what will be the leading factor?
Thursday: JOLTS job openings in the US
Our thoughts: the Fed would like to accomplish the unusual feat of eliminating excess job openings without necessarily increasing the number of unemployed. Right now, however, there are nearly 5 million more job openings than jobseekers, which makes the Fed’s job very difficult. Are these job openings real and will they fall? The JOLTS (Job Openings and Labor Turnover Survey) data will guide markets as to the size of the task for the Fed and hence clues on future interest rate policy.
Friday: US non-farm payrolls and employment report
Our thoughts: just like the JOLTS number, the non-farm payroll number will be parsed carefully, although markets often don’t go much beyond the headline. Another quarter of a million new jobs are expected to be created in September. Although the rate has reduced over the past months, it is still uncomfortably high for the Fed. The other important data are the labour force participation rate and average hourly earnings. The former indicates whether new entrants to the workforce are coming to pick up the extra job openings. The latter whether wage inflation is becoming entrenched.
The numbers for the weekSources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Bank of England swoop on gilts was triggered by concerns about financial stability
The FPC of the BoE, announced the purchase of gilts, the full backing and funding from the Treasury, in a £65bn move designed to calm gilt markets in the face of many pension fund investors who followed so-called ‘liability-driven investment strategies’ being forced to sell gilt assets to meet margin calls. This was a financial stability action, not a monetary policy decision.
BoE Chief Economist Huw Pill said the UK’s government’s fiscal announcement and the market reaction that followed it requires a significant monetary policy response, with the BoE making a ‘full assessment’ of the government’s budget plans in November.
Investors are currently pricing in about 160 bps of Monetary Policy Committee hikes in November and pricing in close to 4% more by May. That would take the BoE’s key rate beyond 6%, from 2.25% now.
Cleveland Fed President Loretta Mester confirmed that the Fed would keep raising rates, saying that “real interest rates have to be in positive territory and there for a time. We’re still not even in restrictive territory on the funds rate”. St Louis Fed President James Bullard reinforced the view that the forecast provided by Fed officials (the “dot plots”) is correct in interpreting future rate hikes by the Fed, with a 4.4% average prediction for the end of this year.
The US White House ruled out another Plaza Accord (like the one in 1984-1985 to bring down the dollar value) to counter the US dollar strength, which obviously did not stem the sharp rise in the greenback.
Generally softer surveys, falling housing data, strong employment, and still sticky inflation
Surveys: the regional surveys were generally disappointing. The Chicago Fed National Activity Index fell from 0.29 to 0.00, the Dallas Fed Manufacturing Activity Index from -12.9 to -17.2, whereas the Richmond Fed was a smidge better at 0 vs -8. The Conference Board Consumer Confidence Index, however, improved for the second month in a row from 103.6 to 108.0, with expectations rising from 75.8 to 80.3 and the present situation from 145.3 to 149.6. The MNI Chicago PMI (Purchasing Managers Index) slumped from 52.2 to 45.7. The University of Michigan Sentiment Index was lower at 58.6 vs 59.5, driven by expectations falling from 59.9 to 58.0 whereas current conditions rose from 58.9 to 59.7.
Industry: durable goods orders fell 0.2% in August, but ex transportation rose 0.2%. Capital goods orders non-defence ex aircraft rose 1.3%.
Consumer: personal income was up 0.3% in August, like the previous month, but personal spending recovered from -0.2% to +0.4%.
Housing: the Case Shiller 20-city index fell from 18.66% year-on-year growth to 16.06%. Also, the FHFA house price index dropped -0.6%. New home sales, however, soared 28.8% in August after negative months all year. MBA mortgage applications fell -3.7% from the previous week. This all happened against the backdrop of surging mortgage rates in the US, with 7% 30-year mortgage rates now.
Employment: initial jobless claims fell again from 209K to 193K, the lowest level since April, with continuing claims also down from 1376K to 1347K.
Growth and inflation: although the Q2 GDP growth revision was flat, the underlying price indices rose, with the GDP price index up from 8.9% to 9.0% and the core PCE (personal consumption expenditures) quarter on quarter from 4.4% to 4.7%. For August, the PCE deflator fell from 6.4% to 6.2% and the PCE core deflator increased from 4.7% to 4.9%, both numbers above estimates. The University of Michigan inflation expectations, fell for the 5-10-year period from 2.8% to 2.7%, but the 1-year inflation rate rose from 4.6% to 4.7%.
Mixed economic data
Surveys: the BRC Shop Price Index rose from 5.1% year-on-year to 5.7% in September. The Lloyds Business Barometer in September was unchanged at 16.
Housing: the Nationwide House Price Index was flat over September for a year-on-year rise of 9.5%, down from 10% previously.
Credit: mortgage approvals rose in August from 63.7K to 74.3K with consumer credit remaining at a 7% year-on-year growth.
Money supply: M4 money supply growth fell from 4.4% to 3.8% year-on-year in August.
Growth: the upward revision of Q2 GDP in the UK (from -0.1% to +0.2%) came mostly from government spending and exports.
Worse surveys and soaring inflation
Surveys: the IFO in Germany was lower and worse than estimates. Business climate fell from 88.6 to 84.3, current assessment from 97.5 to 94.5 and expectations from 80.5 to 75.2. Eurozone confidence fell to the lowest since November 2020, with economic confidence down from 97.3 to 93.7, industrial confidence from 1.0 to -0.4 and services confidence from 8.1 to 4.9. The GfK consumer confidence survey for Germany fell further from -36.8 to -42.5.
Money supply: eurozone M3 money supply increased from 5.7% year-on-year to 6.1% in August.
Inflation: German inflation surged, with the CPI (consumer price index) up from 7.9% to 10.0%, with the EU harmonised rate up from 8.8% to 10.9%, the first double-digit German inflation rate since the advent of the euro. The eurozone CPI rose sharply too, from 9.1% to 10.0% with the core CPI (ex energy, food, alcohol and tobacco) moving from 4.3% to 4.8%.
Generally better numbers from Japan but mixed surveys in China
China: industrial profits were down 2.1% year-on-year in August, on a downtrend for a year and a half.
Mixed Chinese PMIs were published, with the official (CFLP) manufacturing PMI rising from 49.4 to 50.1 but the Caixin manufacturing PMI falling from 49.5 to 48.1 and the CFLP non-manufacturing PMI down from 52.6 to 50.6.
Another Chinese developer, called CIFI, was rumoured to be in difficulties, which put pressure on the Hong Kong market last week.
Japan: the PPI (producer price index) for services fell from 2.1% to 1.9% in August. The August industrial production jumped 2.7% on the month for a 5.1% year-on-year growth, housing starts rose 4.6% year-on-year up from a negative 5.4% the prior month and retail sales also improved, up 1.4% on the month for a 4.1% year-on-year growth. Consumer confidence, however, deteriorated from 32.5 to 30.8. The jobless rate fell from 2.6% to 2.5% in August.
Rally all round
Oil prices rebounded from their post-Ukraine lows, with the Brent gauge nearing US$90/bbl mid-week, finishing just below US$88. Gold staged a rally too, concomitantly with the crisis in the gilt market, as the yellow metal is seen to be protective in case of financial institutional instability. At the end of the week, Brent was up 2%, copper 1.7% and gold 1.0%, although sterling rallied 2.9% against the US dollar, making these returns negative for UK businesses and investors.