Markets last week
Once again, inflation provided bad news to markets, which reacted to the data in the first part of the week but then reverted to a more bullish view. The eurozone Consumer Price Index (CPI), manufacturing prices paid in the US and shop prices in the UK all posted upward surprises and signalled stickier inflation than expected. Indeed, the 2-year US breakeven rate (expected inflation over that period) rose to 3.3% from 3.0% a week ago and 2.0% at the beginning of the year.
Federal funds futures are now pricing in a peak policy rate of 5.5% in September. The US 10-year treasury bond topped the 4% yield level last week but fell back on Friday to 3.95%. Bond yields surged outside of the US: 10-year gilts finished at 3.85% and German yields at 2.72% (it was exactly one year ago that they emerged from a long period of being negative).
The juggernaut of higher yields was reinforced by central banks reiterating their hawkish message. US Federal Reserve (Fed) officials indicated the need to keep hiking, maybe to a higher level, and leave rates up there until at least sometime in 2024. European Central Bank (ECB) officials mentioned 4% levels. Only the Governor of the Bank of England (BoE), Andrew Bailey, seemed to be hedging his bets, by watering down the need to get back to 2% inflation with comments showing no pre-determined direction for the next bank rate decision.
Regionally, China was on the first page, with Purchasing Manager Indices (PMIs) soaring beyond all estimates in reaction to the full reopening of the economy. As a result, Asian investments did well for a couple of days. Over the weekend, the Chinese Premier Li Keqiang announced an economic growth target of 5% for the Chinese economy, which is generally thought to be modest. Separately, the post-Brexit Windsor deal seemed to help European more than UK assets.
Commodities had a very strong run, with oil and copper topping 3% growth and gold up 2.5%. The weaker dollar during the week did not clip commodity returns meaningfully.
Equities enjoyed the first positive week in four, with European shares particularly buoyant on Chinese PMIs and the Brexit deal. The UK and emerging markets lagged. A mixture of cyclical sectors (energy, materials and technology) performed best whereas defensive areas like utilities and consumer staples barely improved.
The week ahead
Wednesday: Chinese CPI and PPI
Our thoughts: it may still be too early to see the full impact of the post-COVID-19 lockdown reopening on the Chinese economy, but inflation is very important for this recovery. If the consumer is really driving the upswing, then this should get reflected in the CPI but if the old-fashioned infrastructure spending plays resume, then the Producer Price Index (PPI) would reflect it. The PPI is also of the utmost importance for export prices from China to the west. The recent PPI readings have been fortunately negative, as supply chain issues have been mostly ironed out, but could there be another wave now that domestic spending is returning?
Friday: UK January Gross Domestic Product (GDP)
Our thoughts: has the UK managed to avoid the recession after sailing very close to the wind? Given the many conflicting factors in the British economy, knowing which sectors are working and which not, would matter to most investors. The services sector is obviously the most important for the country as a whole, but construction has generally pulled its weight, until recently. Manufacturing and trade have detracted recently so any improvement would be a huge help overall.
Friday: US employment report
Our thoughts: in the current cycle, the US employment report is always somewhat earth-shattering, but the February numbers take particular significance given how strong January was. Were the 517K new jobs created a fluke? Is the number going to be revised down? Is employment still as tight? How about the labour force participation rate which has been weak since COVID-19? What about the average hourly earnings growth? Any indication of how the jobs market is likely to impact inflation will be followed very closely.
The numbers for the week
Central banks/fiscal policy
US and European central banks repeat hawkish message, although BoE Governor seems to be hedging bets
Andrew Bailey, Governor of the BoE said the BoE’s rates are “having an impact” on the British economy and a “further increase in bank rate may turn out to be appropriate.” He was not clear, though, on the future direction of rates, with “caution against suggesting either that we are done with increasing the bank rate, or that we will inevitably need to do more.” He compared the situation to the 1970s and the need to contain inflation.
BoE Chief Economist Huw Pill said the UK economy “is evolving much as we expected it to” but activity and wages have been “slightly stronger.”
Atlanta Fed President Raphael Bostic called for continued rate hikes to above 5% to make sure inflation doesn’t pick up again. “I think we will need to raise the federal funds rate to between 5% and 5.25% and leave it there until well into 2024 … This will allow tighter policy to filter through the economy and ultimately bring aggregate supply and aggregate demand into better balance and thus lower inflation.” His colleague, Minneapolis Fed President Neel Kashkari, expressed his concern about the services sector not slowing down despite the Fed’s rate hikes.
Boston Fed President Susan Collins said “I do believe that we will need to do some additional rate increases and exactly what the right amount is really needs to be dependent on a holistic review of the information that we receive… And then I do believe that it will be important to hold there for some time because it takes a while for the effects of tighter financial conditions to work through the economy.”
Fed Governor Christopher Waller said that if payroll and inflation data become softer, “then I would endorse raising the target range for the federal funds rate a couple more times, to a projected terminal rate between 5.1% and 5.4%. On the other hand, if those data reports continue to come in too hot, the policy target range will have to be raised this year even more to ensure that we do not lose the momentum that was in place before the data for January were released.”
ECB President Christine Lagarde suggested rate rises beyond the next meeting. “At this point in time, it’s possible that we continue on that path. By which amount, in each and every meeting, is impossible to say at this point.” The terminal rate “will be determined by data… What’s very certain is that we’ll do whatever’s needed in order to bring inflation back to 2%.”
ECB Executive Board member Isabel Schnabel said that “the large stock of assets acquired under Quantitative Easing continues to provide significant monetary policy accommodation and may run counter to our efforts to bring inflation back to our 2% target in a timely manner.” Her colleague Pierre Wunsch said how far ECB rates must rise “depends very much on the evolution of core inflation. If we don’t get clear signals that core inflation is going down, we will have to do more”. Looking at rates of 4% would not be excluded … but I want to insist, I won’t make any judgment on where rates would have to go without seeing developments in core inflation.”
Whether manufacturing prices paid, unit labour costs or jobless claims, little good news on the inflation front
Surveys: the ISM (Institute for Supply Management) manufacturing PMI was slightly up from 47.4 to 47.7, below estimates but some of the details helped move markets. The prices paid component soared from 44.5 to 51.3, employment was down slightly from 50.6 to 49.1, new orders rose from 42.5 to 47.0, but the spread between new orders and inventories was still negative, which is not good news for the future of the expansion. The ISM services index was better than expected, at 55.1, down from 55.2 with the employment index rising from 50.0 to 54.0, new orders from 60.4 to 62.6 and prices paid down from 67.8 to 65.6.
Industry: vehicle sales were still strong despite a fall to 14.89m vs. 14.68m expected.
Productivity: non-farm productivity was downgraded during Q4 from 3.0% to 1.7% whereas unit labour costs surged from 1.1% to 3.2%, producing a less satisfactory mix of productivity and costs.
Employment: the jobs market remained very tight, with initial jobless claims at 190K for the week, down from 192K, and continuing claims at 1665K vs. 1660K.
Housing: MBA (Mortgage Bankers Association) mortgage applications had another bad week, down 5.7%. Mortgage rates topped 7% with a 7.10% rate for a 30-year loan.
Mortgage approvals dropping as shop price inflation rises
Surveys: the Lloyds business barometer eased from 22 to 21.
Credit: UK mortgage approvals fell to their lowest since 2009, excluding the pandemic, at 39.6K, down from 40.5K. Net lending securitised on dwellings fell from £31bn to £2.5 bn. Separately, net consumer credit doubled from £0.8bn to £1.6bn, up 7.5% year-on-year.
Inflation: the British Retail Consortium (BRC) said shop price inflation rose from 8.0% to 8.4%, the highest since 2005, when the index started, driven by food prices.
Money supply: money supply (M4) rose 1.3% in January for a 2.7% year-on-year increase, up from 1.6%.
Shock increase in core CPI
Inflation: the CPI was worse than expected, not just in France, Spain and Germany which all stood out, but in the eurozone as a whole, at 8.5%, down from 8.6% but higher than estimates, with the core CPI actually rising from 5.3% to 5.6%. The eurozone PPI, though, dropped sharply from 24.5% to 15.0%.
Employment: eurozone unemployment was unchanged at 6.6%.
Money supply: eurozone M3 money supply eased from 4.1% year-on-year to 3.5%.
Surveys: confidence was a bit softer in the eurozone, with economic confidence at 99.7 vs. 99.8, industrial confidence down from 1.2 to 0.5 and services confidence down from 10.4 to 9.5.
Trade: German exports rose by 2.1% in January after -6.3% the prior month. Imports were still down 3.4%, after -5.6%.
Industry: French industrial production fell 1.9% in January, after +1.5% previously.
Chinese surveys soaring beyond expectations
China: the official (CFLP) non-manufacturing PMI jumped to 56.3 from 54.4 with the official manufacturing PMI up to 52.6 from 50.1. The manufacturing PMI is at the highest level since April 2012. The unofficial Caixin manufacturing PMI also moved up to 51.6 from 49.2 and the Caixin services PMI surged from 52.9 to 55.0. Within the CFLP numbers, production and new orders were particularly strong, but, interestingly, the labour market improved both for manufacturing and services.
Japan: consumer confidence index was almost flat at 31.1 vs. 31.0. The jobless rate fell from 2.5% to 2.4% with the job-to-applicant ratio down to 1.35 from 1.36. Industrial production in January fell 4.3% following +0.3% the previous month. Retail sales rose 1.9% after 1.1%. Housing starts surged 6.6% year-on-year from -1.7% previously.
All commodities were much stronger last week.
As oil prices were recovering, there was a news report on Friday that the United Arab Emirates were planning to leave the OPEC cartel, which depressed crude prices, in particular in the international gauge Brent. The rumour was later denied, and oil prices stormed ahead. Copper bounced back over the US$9,000 level and gold recovered from the low US$1,800.