The numbers for the week – 11 April 2022
Markets last week
In a week where the Ukraine war did not move markets, the US Federal Reserve (Fed) did. Senior Fed Governor Lael Brainard was first to outline an aggressive policy of asset sales (quantitative tightening) by the Fed, shortly followed by the minutes of the previous Fed meeting with the full asset disposal plan. Three more regional Fed Presidents (Bullard, Evans and Bostic) added their comments to the discussion about future rate hikes and sale of assets. Altogether this added to a constant flow of hawkish Fed communication, which had the effect of raising bond yields across the board. The difference between 2-year US treasury bond yields and 10-year yields turned back positive and rose sharply to 20 bps, which was perceived positively for economic growth. This was yet another difficult week for fixed interest markets and set the backdrop for some further changes within equities.
The acceleration of quantitative tightening expected by the markets sent investors to safe haven sectors like healthcare and utilities, whilst technology shares bore the brunt of the selling.
Economic data did not move enormously, other than inflation still surprising on the upside and softer numbers in Europe, but the virus situation in China triggered further lockdowns likely to affect supply chains from the Far East.
As monetary conditions have been getting tighter, with bond yields increasing, corporate bond spreads widening and mortgage rates rising, industry analysts have actually been upgrading corporate earnings and revenues forecasts, mostly in the continued expectation that companies will keep passing on their increased costs.
During the week, the US dollar continued its upward path, with the DXY index (US dollar vs. developed currencies) rising to early pandemic levels. The dollar strength was boosted by concerns about the French Presidential election weighing on the euro. Indeed, the euro was weaker than sterling. Oil prices corrected sharply from their early Ukraine conflict highs but gold kept rising.
In equities, the FTSE 100 was again the star, driven by energy shares, whereas Japan and Europe did worst. Defensive sectors, like healthcare, utilities and consumer staples joined energy among the best performing parts of the market, whereas technology and industrials did worst. Government bond yields rose by a massive 32 bps for US 10-year treasuries, and by about 15 bps for gilts and eurozone bonds.
The week ahead
Tuesday/Wednesday: US CPI and PPI
Our thoughts: another month where inflation is expected to be higher. There doesn’t seem to be any let-up. The CPI (consumer price index) is now estimated to exceed 8% and the core CPI (ex food and energy) is also supposed to rise from its current 6.4%. The PPI (producer price index) is already in double-digits and expected to rise further, putting more pressure on companies to pass their costs on to the final customers. Beyond the direction and magnitude of the headline inflation number, the more interesting questions will be at the detailed level: which parts of the price index are continuing to defy gravity? Is it spreading more broadly? Are there any signs of a reduction in any product or service? Obviously, the US Federal Reserve (Fed) will dissect the data very carefully. Will they find any clues for their rate policy?
Wednesday: UK CPI, RPI and PPI
Our thoughts: likewise, UK inflation will move markets and presumably the Bank of England. The UK, however, gives us a wealth of measurements to pick from: the consumer price index (CPI), the CPIH (CPI including owner occupiers’ housing costs), the RPI (retail price index), the PPI (producer price index) input and the PPI output. Prices have been rising faster for producer prices than consumer prices. All of the readings are estimated to increase this week by at least 0.5%. Will the Bank of England’s MPC (Monetary Policy Committee) be prompted to change its steady rate-increase pattern as a result of the new numbers?
Thursday: US retail sales
Our thoughts: markets are not only concerned about inflation these days. They are also worried about growth, namely the impact of rate increases and the Ukraine war on consumers and their willingness to spend. In light of the relentless rise in government bond yields in the expectation of non-stop Fed hikes, how will the consumer behave? Consumer confidence and sentiment have been depressed but, so far, consumer spending has been unaffected. Retail sales are the acid test of this potential slowdown. The series has been extremely volatile since the pandemic, but will it stabilise to give a sense of direction?
Markets for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed communications overload
US Federal Reserve (Fed) Governor Lael Brainard moved the markets. She called the task of reducing inflation pressures “paramount” and said the Fed will raise interest rates steadily while starting balance sheet reduction next month. “Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–2019”. She said Russia’s invasion of Ukraine is a “seismic” geopolitical risk and human tragedy that skews inflation risks to the upside. Her comments are meaningful because (1) she has been seen as a dove and (2) the onset and speed of QT (quantitative tightening) were still a bit unclear from Powell’s previous comments before the publication of the minutes of the last Fed meeting.
The following day, the minutes of the Fed meeting showed a plan to shrink the Fed’s balance sheet by more than US$1trn a year (the total balance sheet is currently US$8.7trn approximately) while raising interest rates “expeditiously”. Their plan is to reduce existing bond holdings at a maximum pace of US$95bn a month (US$60bn in treasuries and US$35bn in mortgage-backed securities). They debated going bigger than a 25 bp hike last month but chose caution due to Russia’s invasion of Ukraine. The record showed a lot of support among the 16 officials to raise rates by 50 bps.
Later on, St. Louis Fed President James Bullard said he favours raising interest rates sharply. “I would like the committee to get to 3-3.25% rate in the second half of this year,” At the last Fed meeting, Bullard was the only one to vote for 50 bps in an 8-1 policy vote. Bullard has identified himself as the lone dot above 3% for 2022.
Two other regional Fed presidents (Chicago’s Charles Evans and Atlanta’s Raphael Bostic) were more in line with the dot plots (average of all the Fed Governor forecasts for rates). Evans said he would favour moving rates to a neutral level, probably 2.4%, this year or early next. But he said he was sceptical of the need to go further than that. “A lot of what we see are supply chain issues and that those are going to come off the boil.” Bostic said he too favoured moving rates closer to a neutral position, adding “but I think we need to do it in a measured way” and take stock of uncertainties around the outlook.
Service surveys doing well and job market still on fire. No signs of a Fed-induced slowdown
Trade and Industry: factory orders were down 0.5% in February, after +1.5% the prior month, although factory orders ex transport were up 0.4%. Wholesale trade sales rose 1.7% in February, after 5.0% previously.
Surveys: the ISM (Institute for Supply Management) services PMI increased to 58.3 last month, a smidge below estimates, from 56.5 in February. The gain was the first in four months. New orders advanced for the first time since October from 56.1 to 60.1, while employment jumped by the most since January 2021. Business activity also expanded at a faster pace. There was an uptick in business activity in March, but respondents have indicated that they continue to be impacted by capacity constraints, logistical challenges and inflation. Labour shortages have eased slightly. Seventeen industries reported growth last month, led by educational services, entertainment and recreation, utilities and construction. The ISM’s measure of order backlogs rose to a four-month high of 64.5. A measure of prices paid rose to 83.8, nearly the highest since 1997. This means the US economy is not slowing down, but supply disruptions are still rife.
Housing: mortgage applications continued on their downward path, falling 6.3% the week ending 1 April, after -6.8% the previous week.
Employment: initial jobless claims fell sharply from 171K, revised down from 202K, to 166K but continuing claims were revised upwards by 200K, from 1307K to 1506K, with the latest reading at 1523K.
Surveys resilient but growth faltering
Auto sector: UK new car registrations dropped 14.3% year-on-year in March after a positive February.
Surveys: the S&P Global/CIPS construction PMI remained at a high 59.1, defying estimates of a fall, whereas the services PMI was upgraded from 61.0 to 62.6.
Growth: February GDP numbers were disappointing, with overall growth at 0.1%, driven by industrial production down 0.6%, manufacturing -0.4%, the construction output -0.1%, the index of services up 0.2% and the trade balance improving somewhat at £9.3bn deficit vs. £12.3bn the previous month.
Soaring producer prices and softer surveys
Industry: German factory orders slumped 2.2% in February after a positive 2.3% the prior month. German industrial production, however, rose 0.2% in February, down from 1.4% previously.
Inflation: the eurozone PPI (producer price index) rose 1.1% in February for a massive year-on-year increase of 31.4%, up from 30.6% the previous month.
Surveys: the eurozone Sentix investor confidence slumped from -7.0 to -18.0 whereas the S&P Global eurozone services PMI was upgraded from 54.8 to 55.6.
Retail: February retail sales in the eurozone rose 0.3% or 5.0% year-on-year, down from 8.4% previously.
Massive drop in the unofficial China services survey
China: the Caixin services PMI missed estimates heavily, at 42.0 (previously 50.2, estimate 49.7) marking the single biggest drop since the start of the pandemic and worse than the official (CFLP) reading the previous week. Lockdowns are said to be the primary driver of deterioration and a loss of business confidence was noted. It is estimated that 14% of the population and 22% of GDP is currently under lockdown, which is creating a massive economic logjam.
Chinese foreign exchange reserves fell from US$3,213bn to US$3,188bn, still by far the largest in the world.
The March CPI (consumer price index) was 1.5%, up from 1.4% and the PPI (producer price index) 8.3% down from 8.8%.
Japan: labour cash earnings rose 1.2% year-on-year in February from 1.1% the previous month. Household spending, however, fell from 6.9% year-on-year to 1.1% in February. In surveys, the Leading Index CI fell from 102.5 to 100.9 whilst the Coincident Index was almost unchanged at 95.5 vs. 95.6. The consumer confidence index fell from 35.2 to 32.8, but the Eco Watchers Surveys were stronger, the current survey at 47.8 up from 37.7 and the outlook survey at 50.1 vs. 44.4. Lastly, March machine tool orders rose 30.2% year-on-year, slightly down from the previous month at 31.6%.
Oil prices have lost 2/3 of their Ukraine war “premium”
Oil prices have lost almost two-thirds of their Ukraine war premium. After rising from the low US$90s to US$123/bbl, Brent crude prices have fallen back down closer to the US$100 area. The gold price, however, was sustained, moving up to the US$1,940’s.