Markets last week

Last week was dominated by inflation data, with the US CPI (consumer price index) providing a sobering outlook to investors who had been anticipating a smooth downward ride for price increases. At 8.3% headline CPI, the number fell less than expected, but more importantly the details showed that inflation was stickier. The core CPI (ex food and energy) actually rose from 5.9% to 6.3%, driven by higher rents and showing that softer energy costs are not sufficient to bring other prices down. 

Inflationary pressures are lessening at the input level (whether producer prices in the UK, import prices in the US, prices paid and received in US regional surveys, wholesale prices in Germany) but the initial burst of inflation caused by higher energy and goods prices has now spread to other parts of the economy, making the central banks’ job more difficult in trying to tame inflation. Even normally immune Japan posted a surprisingly high 3% CPI print.

Having said that, natural gas prices fell as the European Union started outlining details of its intervention into the energy crisis, including a proposal for targets to reduce electricity demand. Oil prices also fell, leading to lower power prices, although most consumers will not necessarily feel these small differences.

Risk markets reacted badly to the inflation saga. Further, growth issues emerged, with softer economic surveys (the “Philly Fed” in the US, YouGov in the UK, ZEW in Germany and the eurozone). The Atlanta Fed’s GDPNow tracking model, which provides a running forecast of US growth for the current quarter, fell again from a 1.3% forecast to 0.5%, only two weeks after being revised down from 2.6%. The drop in its estimate was mostly caused by lower consumer spending growth.

To make matters worse, on Friday, the market woes were compounded by an announcement from FedEx, often considered to be a bellwether for the whole US economy, that it would be withdrawing its earnings forecast.

All of these movements happened against the backdrop to two major central bank meetings this week: the US Federal Reserve (Fed) tomorrow and the Bank of England on Thursday. The consensus on the Fed hike has hardened from 50-75 bps to 75-100 bps, putting pressure on US government bond yields.

At the end of the week, the US dollar was once again close to a 20-year high, with sterling further weakened by the soft economic data, slumping to a 37-year low and falling against the euro to its lowest level since February 2021. Government bond yields continued their almost relentless rise, with 10-year US treasuries up 18 bps and 10-year gilts up 4 bps. The difference in yields between Italy and Germany reached 2.5%, a level where the European Central Bank was assumed to consider intervening through its Transmission Protection Instrument, but finished at a more moderate 2.28%.

Equities had another bad week, with the US particularly hit and Japan the most resilient of the main markets. Although all sectors fell, information technology was the worst whereas energy, financials and healthcare were relatively more defensive.

Yesterday was a market holiday in the UK in honour of Her Majesty the Queen, but other main markets were open, with Europe flat and the US rising 0.7% and some carry-over in Asia today.

The week ahead

Tuesday: US building permits, housing starts and existing home sales (on Wednesday)

Our thoughts: there is no doubt now that the US economy is slowing down, but there is a world of difference between a slowdown and a recession. Historically, most US recessions have been caused by the housing market collapsing. The data so far point to a correction in frothy housing prices rather than anything more sinister, but this is subject to further incoming data. Building permits and housing starts normally deliver a good health check on the US housing market, to which we can add existing home sales. In light of US mortgage rates exceeding 6%, there must be a concern that the market could be headed for something bigger than a simple correction.

Wednesday: Fed Open Market Committee (FOMC) meeting

Our thoughts: all meetings of the Fed are awaited with bated breath but the one this week takes a bigger importance due to the negative inflation surprise in the US last week. Markets have swung between expecting a 50 bps hike or 75 bps before the CPI print when the dial moved to a toss-up between 75bps and 1%. Again, not only will the actual rate rise matter but the comments accompanying it will be parsed carefully. How far will the FOMC go? What is the expected terminal rate? What do the “dot plots” (future rates expected by every voting official) say? Also, will there be any changes to the quantitative tightening programme (monthly sales of assets into the market)?

Thursday: Bank of England Monetary Policy Committee (MPC) meeting

Our thoughts: just like the Fed, the Bank of England’s MPC is eagerly awaited by the markets. The difference is that the MPC does not provide “dot plots” or future rate changes and hence every meeting has the ability to surprise. How will the MPC factor in the incoming government’s spending plans, in particular the £150bn estimated as the cost to the energy support plan? Is that going to help monetary policy, since inflation could actually look lower as a result of the energy price cap, or would it make money policy conceivably even tighter due to the heavy amount of borrowing which could feed into future inflation?

 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Mixed surveys and solid jobs don’t offset the inflation shocker

Surveys: the NFIB small business optimism index rose from 89.9. to 91.8 in August. The Empire Manufacturing survey (NY State) improved from -31.3 to -1.5, whereas the Philadelphia Fed Business outlook survey (known as the Philly Fed) went the other way from +6.2 to -9.9. The University of Michigan sentiment index was better, but not quite as much as expected: the index rose from 58.2 to 59.5, with both sub-indices improving, current conditions from 58.6 to 58.9 and expectations from 58.0 to 59.9.

Inflation: the August CPI was a huge disappointment, with the headline CPI falling only from 8.5% to 8.3% against expectations of a larger drop and the core CPI ex food and energy actually rising from 5.9% to 6.3%. The PPI (producer price index) final demand fell from 9.8% to 8.7% in August, with the core PPI ex food and energy falling from 7.67% to 7.3% and PPI ex food, energy and trade from 5.8% to 5.6%. the import price index fell from 8.7% year-on-year to 7.8% and the export price index from 12.9% to 10.8%. Lastly, the University of Michigan inflation surveys improved slightly, with the 1-year forecast down from 4.8% to 4.6% and the 5-10-year forecast down from 2.9% to 2.8%.

Employment: the weekly jobless claims continued on their lower trend over the last two months, with initial claims down from 218K to 213K but continuing claims up from 1401K to 1403K. This series bottomed in March at 166K, rose to 261K in mid-July and has been heading lower since, in defiance of the slower economy.

Earnings: real average hourly earnings were -2.8% in August, slightly better than the prior -3.0%.

Sales: retail sales rose 0.3% in August after -0.4% the previous month, but the control group was flat after +0.4%.

Industry: industrial production fell 0.2% in August, down from 0.5% and capacity utilisation eased from 80.2% to 80.0%.

Housing: MBA mortgage applications had another negative week, down 1.2%, after -0.8%. The NAHB housing market index tumbled from 49 to 46, the lowest number since the height of the pandemic in May 2020.

United Kingdom

The CPI surprise was not as bad as in the US, but the issues are similar: lower headline and sticky core inflation

Employment: the claimant count rate was unchanged at 3.9% in August with a small increase in jobless claims to 6.3K and a positive payrolled employees monthly change of 71K vs. 77K the previous month. The ILO (International Labour Organisation) unemployment rate for July fell to the lowest since 1974, at 3.6% in the three months through July. This decline in the jobless rate was driven by a sharp increase in the number of people not seeking employment. A total of 194,000 people left the workforce, the most since the start of the pandemic.

Inflation: the CPI moderated slightly in August from 10.1% to 9.9%, although the core CPI (ex food, energy, alcohol and tobacco) edged up from 6.2% to 6.3%, highlighting the spreading of inflationary pressures in the economy even as energy prices are coming down. The PPI was lower, with the PPI output down from 17.1% to 16.1% and the PPI input down from 22.6% to 20.5%. The BoE/Ipsos inflation forecast for the next 12 months rose from 4.6% to 4.9% in August.

Surveys: the YouGov UK consumer confidence slipped into negative territory for the first time since the pandemic lockdown in the middle of 2020, dropping 4.2 to 98.8 in August.

Sales: retail sales were down 1.6% in August including or excluding auto fuel, the biggest drop this year.

Europe

Continuing to be weaker

Surveys: the ZEW survey fell further with the eurozone expectations gauge down from -54.9 to -60.7. The ZEW for Germany also dropped, with the current situation down from -47.6 to -60.5 and the expectations from -55.3 to -61.9.

Trade: the trade deficit for the eurozone increased from €32.2bn to €40.3bn in July (seasonally adjusted).

Industry: industrial production in the eurozone fell 2.3% in July after +1.1% the prior month. EU 27 new car registrations were finally positive in August, up 4.4% after 13 negative months!

Construction: construction output for July in the eurozone fell 1.3% after -1.2% the previous month.

Inflation: the wholesale price index in Germany was less elevated, at 18.9% year-on-year in August, down from 19.5%.

China/India/Japan/Asia

Better Chinese and Japanese data, but Japan CPI at 3% raises eyebrows

China: the monthly economic data were generally better than expected and the previous month, industrial production up from 3.8% to 4.2%, retail sales up from 2.7% to 5.4%, fixed assets ex rural (i.e. investment) up from 5.7% to 5.8% and surveyed jobless rate down from 5.4% to 5.3%. Only property investment disappointed, down from -6.4% to -7.4%.

Japan: the PPI was 9.0% in August with the previous month revised up from 8.6% to 9.0% as well. Core machine orders rose 5.3% in July from 0.9% previously. Capacity utilisation increased 2.4% in July, after a +9.6% month. The tertiary industry index (i.e. services) fell 0.6% in July, from -0.4% the previous month.

August exports rose 22.1% year-on-year, up from 19.0%, with imports up 49.9% from 47.2%.

The national CPI rose from 2.6% to 3.0% with the core CPI (ex fresh food and energy) from 1.2% to 1.6%.

Oil/Commodities/Emerging Markets

The stronger US dollar weighed on most commodities last week, with energy and industrial metals correcting and gold particularly weaker. Additionally, growth concerns added to lower crude and metals prices. Brent oil fell by 0.9% and copper by 1.3%.