Markets last week
Government bond yields continued to surge globally last week, some driven by the downgrade of US government debt, but most of it extending the trend for higher yields seen over the past two months and in particular in July. The downgrade of US government debt by rating agency Fitch & Co from AAA to AA+ also dragged equity sentiment globally mid-week. Markets quickly related to the previous downgrade of US debt by Standard & Poors downgrading in 2011. This means that Moody’s Investor Services is now the only main rating agency still giving the US its top Aaa rating.
Economic data did not have a huge influence on sentiment, although the US was still reflecting potentially higher growth than in the last two quarters. Indeed the widely followed US Atlanta Fed Gross Domestic Product (GDP) forecast is projecting 3.9% growth in Q3 after 1.8% in Q1 and 2.6% in Q2. The jobs market seems to be slowing down very progressively at a pace that is likely to please monetary authorities and the government alike, helping a lower inflation path without triggering a recession. Other parts of the world were less helpful to the global economy. Europe is still depressed, the UK trying to withstand higher Bank of England (BoE)and mortgage rates, China desperately trying to rekindle consumer animal spirits and only Japan seeming to improve.
The Q2 earnings season was in full swing last week. So far, a high percentage of companies (more than 80% in the US, closer to 60% in other regions) have beaten estimates. Future earnings have been upgraded during the course of this season. Earnings have been particularly weak in the energy and materials sectors.
Higher bond yields took their toll on equities, despite signs of obvious reaccelerating growth in the US, as the fixed interest coupons being offered are starting to cause unhelpful comparison for equity investments. As a result, risk markets were negative.
At the end of the week. Bond yields were higher, in particular in the US helping the US dollar vs. other currencies, especially sterling and the euro. Oil prices were sustained due to further Saudi support and inventory drawdowns, but it was a poor week for equities. Europe came out worst and Japan was once again more resilient. The technology complex had a correction and only energy managed to eke out a positive return in dollar terms.
The week ahead
Tuesday: China CPI and PPI
Our thoughts: whereas the rest of the world does not complain about Chinese Producer Price Index (PPI) being negative, since it means that China is exporting cheaper manufactures, a very weak Consumer Price Index (CPI) clearly indicates lack of growth in the economy, regardless of what other statistics may show. The Chinese authorities have been producing small elements of stimulus but for the time being, consumers seem to be keeping their money in their wallets. A negative CPI is expected, which would not be good news for growth.
Thursday-Friday: US CPI and PPI
Our thoughts: conversely, the world would like lower inflation in the US. The CPI is one of the many such data that could influence the US Federal Reserve (Fed) in its rate-setting decision in September, so it will be watched carefully. After a long string of drops on the headline reading, mostly due to a reversal of energy price rises and downward price pressure on goods, the question is whether CPI has exhausted its easy reduction capability. The more relevant core CPI (ex food and energy) will give us a better understanding of the path ahead for inflation.
Friday: UK June GDP
Our thoughts: the relentless rise in BoE and mortgage rates is widely expected to take a toll on the British economy, but most growth rates so far have hovered round 0% per month. Is the inevitable lag in tightening on the economy eventually creating the oft-mooted recession or will the UK economy be more resilient? Importantly, also, which sectors will contribute to the numbers? The UK is an overwhelmingly services economy but the variability in the data from month to month has been in industry and construction, not to mention the trade balance.
The numbers for the week
Central banks/fiscal policy
BoE rate hike and commentary did not move needle in markets, which were driven by higher bond yields from the US
The BoE hiked interest rates by 25 bps to 5.25% in a vote that was split three ways (with one member of the Monetary Policy Committee voting for no raise and two voting for 50 bps as against six who voted for 25 bps). BoE Governor Andrew Bailey stated that the UK economy has been more resilient than expected, was pleased that goods inflation was falling but concerned about sticky services inflation despite a tiny increase in unemployment. The BoE forecast Q4 inflation at 4.9%, down from the previous 5.1%. Like other central banks recently, the BoE emphasised that the future rate path with be data dependent, but rates will have to remain restrictive for long enough to get back to 2% inflation.
As a reaction, future rate increases were taken down a little by markets to 5.7% and sterling fell. Investors, however, were generally not surprised by the rate move or the BoE’s comments.
Few comments came from officials at the Fed, but Richmond Fed President Thomas Barkin confirmed a view that inflation can be brought down in the US without creating a recession: “there is a plausible story that inflation normalises in short order and the economy dodges additional trauma.” He reiterated the mantra that inflation has to be brought down, because “we learned in the ‘70s that if you don’t get inflation under control, it comes back even stronger.”
Comments were made by various Chinese state institutions about several possible pro-growth regulations announced recently, regarding automobiles and urban development, as well as support for mortgage lenders. This has failed to rouse investor interest so far, but the direction is nevertheless maintained, and markets may well react at some point to the next announcement.
The jobs market is still doing well despite mild softening, productivity seems to be recovering and surveys are holding up
Credit: US banks tightened their credit standards against continued weak demand for loans. The Q2 survey, the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) showed banks expecting to tighten standards further on all types of loans, including the important commercial and industrial loans (C&I loans), up to 50.8%, up from 46% in Q1, but also construction and land development loans up to 71.7% from 68.3%.
Surveys: The Market News International (MNI) Chicago purchasing manager index (PMI) rose from 41.5 to 42.8, The Dallas Fed manufacturing activity index wasn’t as bad at -20.0 vs. -23.2 and the Dallas Fed services activity index was also higher at -4.2 vs. -8.2.
The widely followed Institute for Supply Management (ISM) manufacturing PMI edged up slightly from 46.0 to 46.4. New orders rebounded from 45.6 to 47.3, but employment collapsed from 48.1 to 44.4. Prices paid were a little higher, at 42.6 vs. 41.8.
The ISM services index fell from 53.9 to 52.7, with new orders steady at 55.0 vs. 55.5, employment dropping from 53.1 to 50.7 but prices paid jumping from 54.1 to 56.8.
Employment: the job openings and labour turnover survey (JOLTS) job openings figure fell a tad from 9,616K to 9,582K, although the previous month was sharply revised downward from 9.824K. The quits rate fell further to 2.4%, close to pre-pandemic levels. Jobless claims rose, with initial claims up from 221K to 227K and continuing claims from 1679K to 1700K. The Challenger, Gray & Christmas job cuts fell 8.2% in July compared to rising 25.2% the previous month (meaning that jobs are not being cut).
The July employment report was fairly uneventful, with non-farm payrolls at 187K vs. 185K in June with small downward revisions for the two previous months. The unemployment rate (U-3) fell further to 3.5% from 3.6% with an unchanged labour force participation rate of 62.6% and the underemployment rate (U-6) also dropped to 6.7% from 6.9%. Average hourly earnings were up 0.4% for the month for a year-on-year increase of 4.4% as average weekly hours edged down from 34.4 to 34.3.
Housing: Mortgage Bankers Association (MBA) mortgage applications fell 3.0% in the week ending 28 July.
Industry: the Wards series for total vehicle sales was up at 15.74 million (annualised) from 15.68 million. Factory orders rose 2.3% in June, up from 0.4% the prior month, but ex-transportation orders were up just 0.2%.
Productivity: Q2 non-farm productivity surged 3.7% after -1.2% in Q1. Unit labour costs rose 1.6% in Q2 after 3.3% in Q1, an improvement from the previous negative situation.
Are consumers remortgaging?
Credit: net consumer credit rose £1.7bn in June, up from £1.1bn the prior month, the largest such increase since April 2018. The number of mortgage approvals rose from 51.5K to 54.7K, despite the effective rate in new mortgage loans climbing to 4.63% in June.
Money Supply: M4 money supply fell 0.1% in June for a year-on-year increase of 0.1%.
Inflation: the British Retail Consortium (BRC) announced that shop prices fell 0.1% in July, the first drop in two years, with the year-on-year increase down to 7.6%, vs. 8.4% previously. A significant part of the change was three straight months of deceleration in food inflation.
Housing: British house prices fell at the fastest rate in 14 years, as the Nationwide house price index fell 3.8% year-on-year in July, down from -3.5% the previous month.
Consumer: new car registrations were up 28.3% year-on-year in July up from 25.8%.
Surveys: the S&P Global/CIPS construction PMI jumped unexpectedly from 48.9 to 51.7.
Still looking depressed
Growth: eurozone GDP grew 0.3% in Q2 after slightly negative growth in the previous two quarters.
Inflation: the eurozone CPI eased from 5.5% to 5.3%, although the core CPI (ex-energy, food, tobacco and alcohol) remained at 5.5%. The eurozone PPI fell another 0.4% in June for a year-on-year drop of -3.4%, from -1.6% the previous month.
Employment: the eurozone unemployment rate was unchanged at 6.4%.
Consumer: eurozone retail sales fell 0.3% in June from a -1.4% fall year-on-year, better than the prior month at -2.4%.
Industry: German factory orders surged 7.0% in June after a 6.2% increase the previous month. French industrial production fell 0.9% in June compared to +1.1%. German industrial production unexpectedly fell 1.5% in June.
Surveys: the HCOB construction PMI for Germany softened from 41.4 to 41.0.
China’s weak growth having an impact on the region except for Japan and domestically driven economies
Japan: the jobless rate fell from 2.6% to 2.5% in June, as the job-to-applicant ratio eased from 1.31 to 1.30. The monetary base fell further, down 1.3% year-on-year vs. -1.0% the prior month. The leading index CI eased from 109.2 to 108.9 whereas the coincident index edged up from 114.3 to 115.2.
China: the unofficial Caixin manufacturing PMI fell from 50.5 to 49.2 slipping back into contraction below the 50 threshold. There was a meaningful drop in export orders and employment in manufacturing, as well a purchasing activity. The unofficial Caixin services PMI showed an upside surprise, at 54.1 vs. 53.9, against estimates of a large fall.
Rest of Asia: China’s weak economy had an impact on other countries in the region, most notably manufacturing exporters. Taiwan’s PMI slumped to 44.1, an 8-month low, although South Korea’s PMI was a tad better at 49.4 and Vietnam improved to 48.7 from 46.2. Countries that depend more on domestic spending did better, with 53.3 in Indonesia and 51.9 in the Philippines.
Supported oil price
The US Energy Information Administration (EIA) announced a record fall in US crude oil inventories, down to the lowest level since January. This announcement helped support falling oil prices.
In a further effort to support the oil price, Saudi Arabia announced the extension of its 1 million barrel/day cut to September.