Markets last week
increase in Canadian interest rates, with the Bank of Canada hiking from 4.50% to 4.75% – this came shortly after a similar development in Australia, and in both cases after the central bank had paused rate rises. The US Federal Reserve (Fed) is meeting this week, so these surprises worried global fixed income investors. Futures markets are still pricing the Fed to skip a hike this week and maybe do the final move next month. Futures are also pricing in less in the way of Fed rate cuts between now and year-end: currently only 22 bps, vs. as much as 100 bps at the peak this year.
Despite limited US data last week, there was a sense of weakening momentum in the economy, as the hitherto booming services sector started to show some cracks. An unexpected increase in jobless claims seemed to take back some of the Fed rate risks, assuming that the Fed would be less hawkish against unemployment rising. Chinese statistics were more depressed, amid dropping exports, low consumer inflation and collapsing producer prices, highlighting challenges in the wider global economy as much as within the Chinese consumer. Indeed, the eurozone announced a mild technical recession (two consecutive quarters of negative growth, in this case -0.1% GDP growth in both quarters).
With markets on edge about tomorrow’s US inflation print and the subsequent Fed meeting, government bond yields were again on an upward trajectory. An ongoing deterioration of UK sentiment has brought 10-year gilts to 50 bps more than the equivalent US treasury.
The US dollar took a breather from its recent strength, allowing commodities to recover a little. The oil price, however, fell further, despite the previous week’s announcement of output cuts by Saudi Arabia, mostly reacting to economic weakness in China.
Equities were somewhat temperamental against that backdrop. Geographically, there was an unusual East-West split, as European, UK and US shares fell but Japanese and Chinese markets rallied. The more interesting development, though, was the incipient rotation from technology into other sectors, notably industrials and energy, and also into smaller shares in the US, although the “megacaps” still had a very strong week. There seem to be high expectations that this rotation could broaden the very narrow US market and enable it to move to new highs, after hitting a landmark 20% rally – the technical definition of a bull market – during the week. It is probably too early to make such a judgment, though, since liquidity is expected to shrink as the US Treasury refinances its general account by issuing government securities.
The week ahead
Tuesday: US consumer price index (CPI)
Our thoughts: US inflation has been stickier than expected, in particular at the core level, due to services prices being driven by a tight jobs market, while energy prices have been coming down and goods prices have also helped lower the headline CPI. There is an expectation that both headline and core CPI will come down this week and, after the Canadian and Australian hikes, US inflation will return to front of mind. With the Fed meeting on the same day, the latest number is likely to influence the decision.
Wednesday: US Federal Reserve decision
Our thoughts: is a skip a pause or is it just extra time for reflection? Markets seem to have moved from thinking the former to the latter. After raising rates by 5% over 14 months and indicating that monetary tightening operates with some variable lags, it appears possible that the Fed might want to wait and see for at least one meeting. Part of their decision will depend on the most recent inflation data – not just the CPI mentioned above but also the producer price index (PPI) coming the next day, in the middle of the Fed’s discussion. Another part of their decision may be based on other statistics or simply on the balance of probabilities. Markets are now expecting a skip this week and a hike next month. Will the Canadian experience embolden the Fed to give it one more go?
Thursday: European Central Bank (ECB) decision
Our thoughts: there has been a coordinated central bank policy across developed countries in response to high inflation, so a move in one central bank has often foreshadowed similar moves in others. The ECB is likely to pay attention to what the Fed does and says, but its own 20-country economy is much weaker than the US currently so this may have an impact on their decision (as well as of course the lower current level of eurozone rates vs. US rates). The hawks among the Governing Council of the ECB have been more communicative recently whereas the doves have been silent, so it’s difficult to gauge the balance of opinions. Markets are expecting the ECB to hike this week and then one another time before pausing. What will be more relevant for investors will not be the almost-foregone 25 bp hike this week, but any hints on future moves which will come out in President Christine Lagarde’s comments and Q&A.
The numbers for the week
Central banks/fiscal policy
Canada and Australia upstage the bigger central banks
A number of officials from the ECB suggested that its rate hikes still had further to go, although they were mostly in the “hawkish” camp. Klaas Knot said he’s ‘not yet convinced that the current tightening is sufficient’, while Isabel Schnabel said there is ‘more ground to cover’ and Gabriel Makhlouf claimed that ‘more work is needed from monetary policy in the short run’.
There was an unexpected increase in Canadian interest rates, with the Bank of Canada hiking from 4.50% to 4.75%, which came shortly after a similar development in Australia and worried global fixed income investors.
Some incipient cooling in the jobs market amid softer services growth
Industry: factory orders were up 0.4% in April, but ex transportation they were down 0.2%. Wholesale trade sales rose 0.2%, below estimates, after a large fall of 2.7% the previous month.
Surveys: the Institute for Supply Management (ISM) services index disappointed, with the headline down from 51.9 to 50.3, driven by new orders down from 56.1 to 52.9. Prices paid also fell from 59.6 to 56.2 and employment crossed into contraction from 50.8 to 49.2.
Trade: the US trade gap expanded in April from US$60.6bn to US$74.6bn, the largest deficit in six months.
Housing: Mortgage Bankers Association (MBA) mortgage applications fell 1.4% in the week ended 2 June, the fourth in a string of negative numbers.
Employment: jobless claims surprised in both directions. Initial claims surged against expectations from 233K to 261K, the highest level in 20 months, whereas continuing claims fell from 1794K to 1757K, against estimates of an increase.
Mixed data with weak housing and retail but better auto sales and construction
Housing: average UK house prices fell 1% in May year-on-year to £286,532, the first annual decline since 2012, in the Halifax survey. The Royal institute of Chartered Surveyors (RICS) house price balance in May improved from -39% to -30%.
Consumer: the British Retail Consortium (BRC) sales like-for-like year-on-year fell from 5.2% to 3.7% in May. New car registrations accelerated in May from 11.6% year-on-year to 16.7%.
Construction: the S&P Global/CIPS construction Purchasing Managers’ Index (PMI) rose from 51.1 to 51.6.
Very mild technical recession in the eurozone
Surveys: the eurozone Sentix investor confidence fell from -13.1 to -17.
Inflation: the PPI fell sharply from 5.9% to 1.0%.
Growth: the eurozone had negative growth of 0.1% during Q1 in a downward revision, after a similar rate in Q4 2022, meaning that technically it was in a recession.
Consumer: eurozone retail sales were flat in April following an upward-revised -0.4%, for a year-on-year -2.6%, up from -3.3%.
Industry: German factory orders unexpectedly fell 0.4% in April for a -9.9% fall year-on-year. While industrial production rose 0.3%, the year-on-year growth fell from 2.3% to 1.6%.
Construction: the German construction PMI increased from 42.0 to 43.9, albeit still in contraction territory.
Chinese economy still flagging and Japan a little softer
China: the biggest banks have been asked by the government to cut their interest rates, in an effort to boost the flagging economy. Chinese exports fell more than expected, though imports were still less bad. Exports decreased 7.3% year-on-year whilst imports were down only 4.5%. As a result, foreign exchange reserves fell somewhat from US$3,204.9bn to US$3,176.5bn.
The CPI edged up marginally from 0.1% to 0.2% but the PPI fell further from -3.6% to -4.6%.
Japan: labour cash earnings increased 1.0% year-on-year, down from 1.3% previously, and household spending fell sharply from -1.9% to -4.4% year-on-year. The Leading Index CI edged up from 96.9 to 97.6 and the Coincident Index from 99.2 to 99.4. The Eco Watchers survey was mixed, with the current reading up from 54.6 to 55.0, but the outlook falling from 55.7 to 54.4.
The money stock was barely changed, with M2 moving up from 2.6% to 2.7% whilst M3 stayed at 2.1%. The PPI fell from 5.9% to 5.1%.
Machine tool orders for May deteriorated to -22.2% year-on-year vs. -14.4% the previous month, an important bellwether for global manufacturing activity.
The weaker US dollar boosted industrial metals and helped stabilise gold, but the unilateral Saudi output cut in crude did not support oil prices during the week, as weak Chinese data dominated the market.