Markets last week
The first week of the new year saw a resumption of risk appetite despite warnings arising from the minutes of the last meeting of the US Federal Reserve (Fed). A couple of factors led this recovery: the fast-paced reopening of the Chinese economy, and a massive drop in natural gas prices in Europe due to the mild winter.
When the Fed meeting minutes were published, markets didn’t react immediately, but US equities fell the following day. Two statements stand out from these minutes: (1) that no participant in the Federal Open Market Committee (FOMC) saw any rate cuts this year, and (2) that if markets were too bullish and further loosened financial conditions, the Fed might decide to hike beyond the currently expected level. Federal funds futures still imply about 40 basis points of cutting this year, in open disagreement with the US central bank’s public statements.
Friday’s US statistics boosted markets again with two numbers being particularly seized upon by bulls: the lower average hourly earnings within the December employment survey, and the large drop in the Institute for Supply Management (ISM) services Purchasing Managers Index (PMI), the implication being that inflationary pressures within the services sector and wages are decreasing. Hopes of an economic ‘soft landing’ in the US were kindled by the data. Both these readings came during a week of strong employment statistics, however.
Markets were quite mixed as a result of these diverse factors. The two lagging equity areas were Japan and the US, both reflecting a more hawkish recent discourse from the Bank of Japan and the Fed, respectively. Within the US market, technology shares suffered amid large job cuts from giant firms and earnings downgrades from analysts, but the worst sector was energy, as crude prices fell sharply, probably mostly driven by the mild winter.
The strongest stocks over the short week were those driven by the Chinese market, whether in China itself or western companies doing significant business in the country. The divergence between countries and sectors also explains why the US dollar staged a major recovery which is unusual in a risk-on environment, although the improvement was reversed on Friday with the strength in US equities.
Government bond yields fluctuated sharply as markets struggled to digest mixed economic data and the Fed’s message with the direction being nevertheless down in the expectation that lower inflation readings will eventually soften the resolve of the major central banks. Indeed, better Consumer Price Index (CPI) numbers in Europe were seen as a bellwether for global inflation. US treasury bonds picked up a strong bid on Friday with the employment and survey data.
The warm January weather and rolling forecast also helped bring down oil prices, despite any expected Chinese economic upswing due to the rapid reopening.
The attempt at a US dollar rally fizzled on Friday due to the perception of a soft landing. The dollar has not affected gold prices, which have now rallied more than US$200/oz in the last two months.
The week ahead
Wednesday: Chinese inflation data
Our thoughts: Chinese inflation has an impact on the rest of the world in two ways: through Chinese exports, making the Producer Price Index (PPI) more relevant, and through Chinese economic growth pulling or dragging other countries, which makes the Consumer Price Index (CPI) more important.
Thursday: US CPI
Our thoughts: no statistics are more closely followed by investors than US inflation data. The CPI, although not the gauge tracked by the Fed, is a vital reading on whether the battle the Fed is waging against inflation is successful. A lower headline CPI is expected, in line with the previous reductions in the CPI from the peak, but the core CPI number (excluding food and energy) will be crucial. Indeed, the sticky inflation element has been mostly in services, whereas the more flexible inflation inputs have been falling (energy in particular). The recent market focus on average hourly earnings will be under scrutiny when checking services inflation.
Friday: UK economic growth for November
Our thoughts: the last three reported months have seen moderately negative GDP growth in the UK. November will be closely watched for any signs of a potential improvement or a downward spiral. The breakdown by sector will also matter. Whether the consumer was already in a spending mode or whether energy costs have curtailed retail activity; how vulnerable manufacturing is and whether construction is holding up despite the fall in house prices; all of these details are liable to move gilt and currency markets and perhaps even domestically focused shares.
The numbers for the week
Central banks/fiscal policy
Fed minutes should have moved markets more
The minutes of the last Fed meeting were published and some of the statements made are worth pondering: “No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023… Participants noted that because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.” And yet federal funds futures still imply about 40 basis points of cutting this year.
Former New York Fed President William Dudley stated that a US economic recession “is pretty likely just because of what the Fed has to do, but what’s different this time I think is that if we have a recession, it’s going to be a Fed-induced recession and the Fed can end the recession by subsequently easing monetary policy… I don’t think that there’s a big risk of a financial-instability cataclysm that pushes the economy into a deep recession”.
St. Louis Fed President James Bullard, who was seen last year as a hawkish Fed official, said rates were getting “near to high enough” to reduce inflation. Kansas City Fed President Esther George, on the other hand, said she thought rates should “stay above 5%” into 2024 and should stay there “until we get the signals that inflation is really convincingly starting to fall back toward our 2% goal.” Atlanta Fed President Raphael Bostic repeated that there was “much work to do on inflation.”
In Europe, European Central Bank (ECB) Governing Council member François Villeroy de Galhau said the ECB should complete its rate hikes “by the summer” and then be prepared to hold for a long period.
Strong employment numbers throughout contrast with the weaker surveys, factory orders and mortgage applications
Surveys: the Institute for Supply Management (ISM) manufacturing PMI fell from 49.0 to 48.4. Notable among the underlying details were improving supply chains, a strong labour market, easing in price pressures and delivery times as well as new orders in contraction. The main comment from companies in the survey was the difficulty in finding labour.
The ISM services PMI surprised on the downside, falling from 56.5 to 49.6, just below the threshold between expansion and contraction. The details were less encouraging: employment fell to 49.8 and new orders slumped from 56.0 to 45.2, but the prices paid index remained high at 67.6 down from 70.0.
Employment: the Job Openings and Labour Turnover Survey (JOLTS) series showed an upward revision in job openings in October and the November reading came higher than expected at 10.46m vs a 10m estimate. Initial jobless claims were very low during the week, at 204K down from 223K, with continuing claims down to 1694K from 1718K. The Challenger, Gray & Christmas job cuts series rose by 129.1% year-on-year, down from 416.5% (which actually means fewer job cuts).
The monthly non-farm payrolls were higher than estimated at 223K from 256K last month, but the two-month payroll net revision of -28K made the month-on-month change immaterial. The labour force participation rate rose from 62.1% to 62.3% with the unemployment rate dropping to a cycle low of 3.5% and the underemployment rate to 6.5%. Average hourly earnings fell from 4.8% (revised down from 5.1%) to 4.6%, which was perceived very positively by markets.
Housing and construction: Mortgage Bankers Association (MBA) mortgage applications fell 10.3% during the week ending 30 December, down from -3.2%. Construction spending rose 0.2% in November, up from -0.2% previously.
Industry: factory orders in November fell 1.8% from +0.4% the prior month.
Housing and construction still under the cosh
Credit: consumer credit was stronger in November, rising from £0.7 billion to £1.5 billion and net lending securitised on dwellings also increased from £3.6 billion to £4.5 billion, but mortgage approvals fell to the lowest level since June 2020, at 46.1K in November vs. 57.9K the previous month.
Sales: new car registrations fell from 23.5% year-on-year growth to 18.3% in December.
Inflation: the British Retail Consortium (BRC) Nielsen shop price index eased from 7.4% to 7.3%.
Money supply: M4 money supply growth fell sharply from 4.8% year-on-year to 2.5% in November, with the three-month annualised increase dropping from 8.8% to 3.8%.
Surveys: the S&P Global/CIPS construction PMI fell to 48.8 from 50.4.
Housing: the Halifax house price index fell by -1.5% in December vs -2.4% the previous month.
Small improvements in inflation, confidence surveys and retail sales
Inflation: inflation seems to be coming off its peaks in the eurozone. The EU harmonised French CPI eased from 7.1% to 6.7% in December, German import prices fell from 23.5% year-on-year to 14.5% in November. The eurozone PPI fell from 30.5% to 27.1% in November. Finally, the eurozone CPI fell sharply to 9.2% from 10.1%, with the core CPI edging up to 5.2% from 5.0%, showing that a high proportion of the inflationary pressures comes from energy costs.
Trade and Industry: German exports fell 0.3% in November, but imports dropped 3.3% after -2.4% the prior month. German factory orders fell 5.3% in November following a positive month.
Surveys: the S&P Global construction PMI for Germany remained very depressed at 41.7 vs 41.5. Eurozone economic confidence rose from 94.0 to 95.8, industrial confidence from -1.9 to -1.5 and services confidence from 3.1 to 6.3.
Retail: eurozone retail sales in November rose 0.8% following -1.5% previously. French consumer spending rose 0.5% in November, up from -2.7% the previous month.
China: the unofficial Caixin services PMI improved unexpectedly, from 46.7 to 48.0, going against the official (CFLP) non-manufacturing PMI which saw a huge drop.
Japan: the monetary base was slightly less negative at -6.1% year-on-year in December vs a previous -6.4%. Vehicle sales dropped sharply in December to -4.4% year-on-year from +1.0%. The consumer confidence index improved from 28.6 to 30.3, above estimates. Labour cash earnings were softer in November, up only 0.5% year-on-year following +1.4% the prior month.
Energy going against the trend of other commodities could be weather-related
Oil prices have shown huge volatility over the last few years and recently they have not settled into a range. Last week, crude fell again by about 8%, as the Chinese reopening boom wears off and as US economic statistics weaken further, but also as January weather forecasts across Europe seem to suggest a mild winter. The latter explanation is corroborated by the drop in natural gas prices and the strength in industrial metals, which are not reflecting recessionary expectations at this stage.
Gold is on an upward trend now, up more than US$200/oz since the beginning of November.