Markets last week

Against a backdrop of slowing growth, improving global supply chains and receding Omicron infections, markets paid less attention to economic data last week than to announcements by the Bank of England (BoE) and the European Central Bank (ECB).

After a hawkish US Federal Reserve (Fed) the previous week, much was expected from the two systemically important central banks. Those who relish market volatility were not disappointed, as both institutions delivered surprises.

Thursday in the UK was well orchestrated, starting with the energy regulator Ofgem uncapping price rises for UK consumers, followed almost immediately by the Chancellor of the Exchequer trying to alleviate the massive energy cost increases to the population and soon afterwards by the BoE raising rates for the second time in a row. A narrow escape from a 50 bp hike (due to a 5-4 vote for 25 bps) nevertheless rattled markets. The last bit of theatre, however, was still to come that day, with the ECB unexpectedly pivoting to a hawkish stance. Although the ECB did not change its refinancing rate or deposit facility rate, the arch-dove among central banks suddenly acknowledged sticky inflation and refused to rule out future rate rises.

Economic data were still on the buoyant side, whether UK data on housing, surveys and car registrations or US employment and auto sales (both on fire). Throughout the developed world, though, inflation readings were still soaring: US average hourly earnings, the UK shop price index, eurozone consumer and producer price indices, surging oil prices. No wonder central banks are feeling the need to raise interest rates, as modest as the hikes are compared to inflation levels.

The BoE and the ECB triggered another surge in government bond yields, but to a degree rarely seen in this cycle, with most of the weekly increase taking place on Thursday. During the week, 10-year gilt yields rose 17 basis points (bps) to 1.41%, US treasury yields by 14 bps to 1.91%, but it’s the eurozone that saw the greatest yield rises: Germany 25 bps, Italy 45 bps, France 22 bps, Spain 29 bps. It is worth remembering that German 10-year yields had been negative for the last two and a half years.

The euro was the currency winner, due to the unexpectedly hawkish tone from the ECB, rising 2.7% against the US dollar and 1.7% vs. sterling.

The equity backdrop was affected by sky-rocketing yields and pivoting commentaries from central banks, but the major moves came within the technology sector in reaction to disappointing earnings and statements from Meta (formerly Facebook). The huge share swoon was reflected in many other technology stocks. At the end of the week, information technology nevertheless managed to recoup its early losses during the week and eke out a 1.5% gain (despite still being the worst performing sector this year). Energy continued to be the outright winner, up almost 5%, aided by the oil price tailwind with Brent rising 3.6% and the US WTI grade more than 6%. Other strong sectors were financials, up more than 3%, whereas defensive sectors (utilities, consumer staples) were the most subdued.

Chinese markets were closed for the Chinese New Year, but Hong Kong equities soared upon reopening, ending up as the best market last week, together with other Far Eastern countries.

The week ahead

Wednesday: Japanese machine tool orders

Our thoughts: supply chains are a major factor in the current manufacturing inflation and the question is how soon bottlenecks will vanish from global supply chains. In that respect, Japanese machine tools may give an early indication of bottlenecks easing. We have already seen the automobile output start to recover in Japan as semi-conductors and other parts return to the sector. Are machine tools going to give us an early signal of a bottleneck recovery?

Thursday: US CPI (consumer price index)

Our thoughts: inflation is obviously the greatest issue right now. Nowhere more than in the US, with Fed policy determining global risk appetite. The January CPI is expected to increase further from the eye-watering 7.0% headline and 5.5% core reading in December. The level of the rise and the spread of price increases throughout the inflation basket will make a difference to future data and to the Fed’s decision on interest rates next month.

Friday: UK monthly GDP for December

Our thoughts: once again, the monthly GDP data for the UK provide more granularity than in other countries. The British economy has been surprisingly resilient to Omicron restrictions and the plight of a services sector running out of employees. Are services the big loser and is construction still on a tear? Or will manufacturing continue to provide needed ballast to the broader GDP? How bad will the trade balance be? The expectations are quite subdued for December after a strong November, given a large drop in retail sales.

The numbers for the week 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

A tale of two central banks, one raising rates, the other not and yet the currency of the one not hiking is the winner

UK Chancellor Rishi Sunak pledged £9bn “to take the sting out of a significant price shock for millions of families”, after a price cap increase from energy regulator Ofgem raising domestic gas and power bills by £693 for 22 million customers. Sunak said the government action would offset the hike by £350.

Hot on the heels of that announcement, the Bank of England (BoE) lifted its key interest rate from 25 bps to 50 bps, but nearly delivered an unprecedented 50 bps increase, with a 5-to-4 vote for 25 bps only. The rate increase last week marks the first back-to-back hike since 2004. The BoE announced it would start to unwind the £895bn gilt purchase programme and would immediately stop reinvesting the proceeds of expired gilts, allowing more than £200bn to run off by 2025. It also announced plans to offload the entire £20bn stock of corporate bonds by the end of 2023.

The BoE lifted its forecast for inflation to peak at 7.25% in April but will be back to a little above the 2% target in 2 years and then drop below target. They sharply increased their wage-growth forecast, predicting the underlying pace will hit 4.75% in the coming year. Markets are now close to pricing in a level of 1.5% in BoE rates by the end of this year, which would the biggest tightening of policy for any calendar year since 1997.

But it’s the European Central Bank (ECB) that really moved markets. In a markedly more hawkish tone than in December, saying inflation risks are “tilted to the upside”, ECB President Christine Lagarde pivoted on guidance on rates for this year. She reiterated that they would slow bond-buying across 2022 and end asset purchases entirely before raising borrowing costs. Importantly, Lagarde refused to rule out an interest rate hike this year, in a major change from previous meetings. Emergency bond purchases are expected to end in March. Markets now see a hike in July and 40 bps of tightening by year end.

United States

The job market is on fire, belying talk of a Q1 slowdown

Surveys: the MNI Chicago PMI rose from 64.3 to 65.2 against an expected drop, whereas the Dallas Fed manufacturing activity index fell from 7.8 to 2.0 against estimates of an increase. The Markit manufacturing PMI rose from 55.0 to 55.5, but the more important ISM (Institute for Supply Management) manufacturing PMI fell from 58.8 to 57.6, marginally above estimates. New orders were down from 61.0 to 57.9, employment up from 53.9 to 54.5 but prices paid surged again from 68.2 to 76.1. Customer inventories are still down at 33 despite inventories for manufacturers rising, which should continue to support the manufacturing sector. The ISM services index fell from 62.3 to 59.9, still a very strong level. The report described available labour as inexistent. Business activity dropped to 59.9 from 68.3; new export orders nosedived to 45.9 from 61.5; the supplier-deliveries index increased to 65.7; and inventories improved to 49.4 from 46.7.

Employment: job vacancies now outnumber people looking for jobs by the greatest amount since the series started (1.7 times), as job openings rose unexpectedly in December to 10.9 million. The quit rate declined slightly, at 2.9% from a record 3% in the prior month. Initial jobless claims eased from the previous 261K to 238K, and continuing claims also fell from 1672K to 1628K. The Challenger, Gray & Christmas jobs cuts in December were down another strong 76% year-on-year, almost unchanged from the previous month.

The January employment report was surprisingly buoyant. Non-farm payrolls rose by 467K vs. only 125K expected and a previous negative reading from the ADP employment firm. In addition, there were huge upward revisions (+709K over the last two months). Unemployment (U-3) rose from 3.9% to 4.0% but with the labour force participation rate increasing from 61.9% to 62.2%, despite Omicron, and the underemployment rate (U-6) kept falling from 7.3% to 7.1%, approaching the 6.8% all-time low.

Inflation: the averages of the prices-paid and prices-received indices in the regional business surveys conducted by five Fed district banks have remained at record highs for the past six months. In the employment report, average hourly earnings rose from 4.9% to 5.7% but the average weekly hours worked fell from 34.7 to 34.5, complicating the short-term analysis.

Housing: after a negative week, MBA mortgage applications surged 12% last week.

Costs: Q4 productivity and labour costs are striking a positive balance, after a dreadful Q3, with productivity up 6.6% whilst unit labour costs increased only by 0.3%.

Industry: factory orders for December fell 0.4% but ex transportation they edged up 0.1%. The Wards total vehicle sales bounced back sharply from 12.44 million to 15.04 million annualised in December.

United Kingdom

Positive numbers throughout, but inflation an issue

Housing: the Nationwide house price index for January rose 0.8% or 11.2% year-on-year, the strongest start to the year since 2005. Mortgage approvals rose from 67.9K to 71K in December.

Inflation: the BRC (British Retail Consortium) shop price index shot up 1.5% in January, up from 0.8% in December.

Money supply: M4 money supply growth declined from 7.0% year-on-year to 6.4% in December.

Surveys: the Markit/CIPS services PMI increased from 53.3 to 54.1 and the Markit/CIPS construction PMI surged from 54.3 to 56.3.

Auto sector: new car registrations year-on-year rose 27.5% in January after a -18.2% reading in December.

Europe

Mixed data, but inflation also a big issue

Inflation: euro-area CPI (consumer price index) inflation unexpectedly accelerated to a record of 5.1% in January, way above the median estimate. Core inflation was 2.3%, down from 2.6 %. The eurozone PPI (producer price inflation) rose 2.9% in December for a 26.2% year-on-year growth.

Sales: German retail sales in December were down 5.5%. Eurozone retail sales fell 3% in December, rising 2.0% year-on-year vs. +8.2% the previous month.

Employment: the eurozone unemployment rate fell from 7.1% to 7.0%.

Surveys: the Markit eurozone services PMI eased from 51.2 to 51.1. The Markit construction PMI for Germany surged from 48.2 to 54.4.

Industry: German factory orders rose 2.8% on December after a 3.6% increase the previous month.

China/India/Japan/Asia

Limited data due to Chinese New Year

China: closed for the week due to the Chinese New Year holidays, but over the weekend the Caixin services PMI dropped from 53.1 to 51.4, albeit above estimates.

Japan: the job-to-applicant ratio edged up slightly from 1.15 to 1.16 with the jobless rate declining from 2.8% to 2.7%. Vehicle sales for January fell 12.5% year-on-year down from -10.2% previously. The monetary base increased to 8.4% year-on-year in January from 8.3%. The Leading Index CI edged up from 103.9 to 104.3 and the Coincident Index slid from 92.8 to 92.6.

Oil/Commodities/Emerging Markets

Oil is still soaring

OPEC and its allies agreed to make another modest output increase in March of 400,000 barrels (bbls)/day, sticking to their plan even as several members failed to deliver the scheduled monthly supply hikes. OPEC’s 13 members increased production by only 50,000 barrels a day in January, which is why the crude price is still well supported, racking up its seventh weekly gain, apparently headed for the US$100/bbl level.

Other commodities, notably industrial metals, had a very strong week too.

Gold prices see-sawed round the US$1,800 level.