Markets last week

Markets see-sawed between relief and despair during the past week. The US Federal Reserve (Fed) delivered a message of steady interest rate hikes which was less hawkish than market participants had expected and hence boosted risk investments. The next day, however, concerns about that particular message and economic slowdown drove equities and bonds into the opposite direction and wiped out previous gains.

Some economic numbers contributed to the negative mood. Chinese services surveys hit a low since the early COVID-19 period; the Bank of England delivered its gloomiest message on the UK economy in decades; and the comparison between productivity and employment costs in the US for the first quarter (Q1) was as dire as it is possible to imagine, a bad omen for the Fed’s inflation fight. The combination of these concerns piled up pressure on risk assets in the second half of the week.

The European Union issued a ban on Russian oil, which supported crude prices and helped the energy equity sector in a week where almost all other sectors suffered. The US dollar continued its relentless rise, with sterling dropping to its lowest level in two years after the Bank of England’s statement. The most significant move, however, was in government bond yields, soaring across the board, particularly in the US, reflecting concerns that the Fed would have to hike much more than announced. The US jobs data on Friday highlighted a lower employment participation rate, which is likely to worry policymakers, since employment costs are unlikely to abate that soon.

At the end of the week, equities were down significantly, with the exception of Japan. Government bond yields rose again (by 15 basis points (bps) for US and European 10-year yields) with the US 10-year treasury bond exceeding 3% for the first time since 2018 and the 2-to-10-year yield curve (difference in yields between two and 10 years) up to 30bps.  Sterling was the weakest developed currency, following the Bank of England statement. Oil prices continued their ascent, up 4% on the week, whereas copper was flat, and gold increased marginally.

In equities, once again the market leadership was still overwhelmingly in energy, with defensive sectors marginally positive. At the other end of the spectrum, several sectors fell, not just technology, but also materials, real estate and healthcare. The strongest market was Japan, and the most negative returns were in emerging markets, in particular in China, and small companies in the UK.

The week ahead

Tuesday: China CPI and PPI

Our thoughts: the world may not care much about the Chinese CPI (consumer price index) other than envy for a sub-2% number, but the Chinese PPI (producer price index) matters a lot to markets, since China is at the origin of most industrial supply chains and exported inflation builds into Western consumer prices. There is an expectation for the PPI to continue on its moderate downward trend, which together with a lower renminbi (Chinese currency) level, should help reduce imported inflation elsewhere. Of course, the bigger issue now is the COVID-19-related lockdowns in China, but if they are not reflected in higher supplier prices, maybe the problem is less than anticipated.

Wednesday/ Thursday: US CPI and PPI

Our thoughts: after the Fed’s meeting with a clear guidance on interest rate hikes, the market will be wondering when the Fed might change its mind. Future inflation numbers will be crucial to that possible decision. There is currently an expectation that the US CPI will abate in April, both for the headline reading and the core CPI (ex food and energy). Whether this is confirmed and where it comes from, will be important to the Fed, although it is likely to take several months of falling inflation for the Fed to alter its rhetoric, let alone its actions. Worth watching nevertheless. The PPI is due the next day and, again, will a fall in the numbers make a difference to Fed watchers?

Thursday: UK March GDP with breakdown 

Our thoughts: Bank of England Governor Bailey spooked the markets last week with forecasts of economic stagnation in the UK. In light of this, monthly growth data are likely to be scrutinised very closely by markets. The March GDP will follow a disappointing February and is currently expected to be flat, after what was a very strong 2021. The question, in addition to the headline growth reading, is about the underlying sectors. Construction and services are anticipated to be positive whilst manufacturing and industrial production are supposed to be flat. Is this the beginning of the stagnation forecast by Governor Bailey?

The numbers for the week 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Fed’s relatively positive message lasts less than 24 hours, whilst Bank of England’s forecasts hit sterling

The US Federal Reserve hiked its Fed funds rate by 50bps and specified likely 50bp hikes at each of the next two meetings in June and July. Fed Chair Jay Powell indicated that by the end of July, the Fed funds rate would likely be 2%. He downplayed a possible 75bp hike anytime soon, which set the US stock market on fire, but for one day only.

The Fed announced its balance sheet run-off for Treasury bonds and mortgage-backed securities at an initial combined monthly pace of US$47.5bn in June, stepping up over three months to US$95bn.

Powell stressed they are aiming for a soft landing, but the committee are calling themselves ’highly attentive‘ to inflation risks. Powell spoke ’directly to the American people’ to start off his press conference, noting the Fed’s commitment to bringing inflation down. The risk is still that longer-term inflation expectations become unanchored.

Powell also spoke about the things the Fed can’t fix: the Russia/Ukraine conflict and COVID-19-related lockdowns in China, which are both likely to exacerbate supply chain disruptions. The Fed can only help with the demand side of the economy, not the supply side, which points to a limit to its hawkishness. In fact, Powell said: ”Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” ’Broader price pressures‘, which is what they can work on, comes last on the list. This was perceived positively by the markets for 24 hours, before veering in the opposite direction. 

The Bank of England lifted its key rate by a quarter point (25 bps) to 1%, with three officials voting for an even larger move.   The Bank unveiled the gloomiest outlook of any major central bank this year, warning Britain to brace for double-digit inflation and a prolonged period of stagnation.

According to the Bank’s own forecasts, British households are facing a 1.75% drop in real disposable income this year, the second biggest fall since 1964; GDP growth is expected to drop slightly next year (-0.25%) whilst avoiding a technical recession (which is two negative quarters in a row) and inflation could top 10%.

Other Bank of England forecasts were:

– Inflation climbing above 10% in October

– Pay growth rising to 5.75% in 2022, before falling in the following two years

– Unemployment dropping this year before climbing to 5.5% by 2025

– The economy stagnating in 2024, with 0.25% growth.

Sterling was hurt by Governor Andrew Bailey’s comments, falling 0.7% vs. the US dollar and 0.4% vs. the euro to the lowest levels in almost two years.

United States

The Q1 productivity vs. labour cost equation threw markets into a tailspin

Housing: the 30-year mortgage rate has moved from 3.29% at the start of this year to 5.54% early last week. MBA mortgage applications rose 2.5% during the week, after a string of falls.

Employment: record levels of job openings and workers quitting were announced in March, pointing to intensifying labour market tightness that should keep pushing wages higher. The number of job openings increased to 11.5 million in March from 11.3 million. A record 4.5 million Americans quit their jobs in March (the series started in 2000), with the quit rate rising to 3%. There were 1.9 job openings for every jobseeker.

Non-farm payrolls for April were identical to March at 428K jobs created. The net two-month revision was -39K, which is minor and mostly centred on February.

The unemployment rate (U-3) remained at 3.6% and the underemployment rate (U-6) actually rose from 6.9% to 7.0%. The all-important labour participation rate went down from 62.4% to 62.2%, which highlights a supply problem and does not help the inflation story.

Initial jobless claims rose from a low 181K to 200K whereas continuing claims kept falling, from 1403K to 1384K.

The Challenger job cuts finally turned positive, up 6.0% after over a year of negative job cuts, which means companies are finally cutting jobs again.

Industry: factory orders were very strong, up 2.2% in March, 2.5% ex transportation. The Wards series for total vehicle sales improved from 13.33 million to 14.29 million (annualised).

Surveys: the ISM (Institute for Supply Management) services index fell from 58.3 to 57.1, although it is still a healthy growth number.

Productivity and costs: Q1 productivity fell by a huge 7.5% and unit labour costs rose 11.6%, a massive 19% discrepancy. Even accounting for the enormous volatility of this series (the previous quarter was +6.3% for productivity and +1% for unit labour costs), this is still dreadful and shows that inflation could be stickier for longer. The 20-quarter growth rate for productivity, however, is still at 1.5%, better than the 0.5% at the end of 2015.

Earnings: average hourly earnings were up 0.3% in April, down from 0.5%, with the year-on-year growth down from 5.6% to 5.5%. Average weekly hours were unchanged at 34.6.

United Kingdom

Housing still doing well

Prices: the BRC shop price index rose from 2.1% to 2.7% in April.

Credit: consumer credit rose 5.2% year-on-year in March, better than the previous 4.5%. Mortgage approvals were almost unchanged but net lending secured on dwellings surged from £4.6bn to £7bn.

Money supply: money supply (M4) eased a little from 6% year-on-year to 5.4%.

Housing: UK house prices rose for a tenth straight month in April as shortages of property for sale continued to underpin the market. The average value of a home hit a record £286,079, per mortgage lender Halifax. Prices rose 1.1% from March and year-on-year at 10.8%.  

Automotive sector: new car registrations fell 15.8% year-on-year in April, down from 14.3% the prior month.

Surveys: the S&P Global/CIPS construction PMI fell from 59.1 to 58.2, still a strong level.

Europe

Not much in the way of good news

Inflation: the eurozone PPI (producer price index) surged from 31.5% to 36.8% year-on-year after a 5.3% jump in March. Even if a small part of this enormous cost inflation goes into consumer prices, it could feed into inflation and/or cut company margins.

Employment: the eurozone unemployment rate improved marginally from 6.9% to 6.8%.

Sales: eurozone retail sales fell 0.4% in March.

Industry: German factory orders slumped 4.7% in March, the second negative month.

China/India/Japan/Asia

Shocking services slump in China

China: the unofficial Caixin services PMI dropped from 42 to 36.2, worse than the official non-manufacturing PMI at 41.9 and the worst level since the early COVID-19 period, reflecting the impact of lockdown on consumer spending.

Exports year-on-year rose 3.9% in April, down from 14.7% the previous month, and imports were flat. Chinese foreign exchange reserves fell somewhat in US dollar terms, from US$3.19trn to US$3.12trn.

Japan: the monetary base rose 6.6% year-on-year in April, down from 7.9% previously.

Oil/Commodities/Emerging Markets

After the EU ban on Russian oil, crude prices surged and finished the week more than 4% higher, with Brent at US$112/bbl and the US gauge WTI approaching US$110.  Gold recovered a little but could not hold on to the US$1,900 handle.