Markets last week
In a week curtailed by the US Labor Day holiday, central banks were once again the focus, with the European Central Bank (ECB) hiking interest rates by an unprecedented 0.75% and senior officials at the US Federal Reserve (Fed) confirming the upward path for interest rates.
The ECB delivered a 75 bp rate increase with the intimation that further tightening would ensue, although not necessarily at the same speed. The ECB’s rate increase followed the Bank of Canada’s 75 bps and led markets to expect the same 75 bps from the Fed next week, despite widely held expectations of a lower inflation reading in the US tomorrow.
The UK was the focus of attention in the world, with the new Prime Minister Liz Truss announcing a massive (£150bn) plan to cap energy costs to households and the passing of Her Majesty the Queen. The PM’s emergency plan helped drive sterling further down and gilt yields to yet another high, based on the expected level of borrowing needed to finance the energy price cap.
During August, the global composite PMI edged down to 49.3, the first reading below the 50.0 demarcation between contraction and expansion since June 2020. Whereas the manufacturing PMI edged down slightly to 50.3, the non-manufacturing index fell more sharply to 49.2, showing that the services sector is where global weakness now lies. Other economic data did not move markets, simply confirming existing trends: a weaker European economy, US employment still very strong, falling housing markets in the US and UK and a more resilient Far East. The only meaningful surprise was another downward move in Chinese inflation, including the PPI (Producer Price Index) which should bode well for import prices worldwide.
Against that backdrop, markets staged a rally from the previous steep correction with the US at the helm. Government bond yields surged again on the relentless central bank policy media blitz. The 10-year gilt is now within catching distance of the 10-year US treasury yield, at 3.10% vs. 3.31%. The US dollar took a small breather, allowing industrial metal commodities to rally, with copper up nearly 3%. Oil prices were more muted, however, in part due to the Ukrainian counter-offensive and the European Union plan to deal with Russian gas shortages.
Stock markets recovered with the US at the top and Asia lagging. Cyclical and growth sectors dominated, with consumer discretionary, healthcare, technology and materials rising between 3% and 4%, whilst energy stalled after leading during most of the year.
The week ahead
Tuesday: US CPI
Our thoughts: the US CPI (consumer price index) is arguably the most followed and anticipated piece of data in the world right now, as the key to future US interest rates and hence all other world markets. This is the second month in a row where a fall in the headline CPI is expected, but the details could matter as much as the top number. If headline CPI is falling but core CPI (excluding food and energy) is not, or is still rising, does this mean that the headline reading is only reflecting lower oil prices but that the rest of the economy has been infected by higher inflation? Have any specific products or services been instrumental in the CPI move, and do they reflect a trend or simply a correction from previous trends? The analysis can be tricky and stir markets as much as the number itself.
Wednesday: UK CPI, RPI and PPI
Our thoughts: UK inflation has been expected to skyrocket by economists, politicians and the Bank of England itself. Now in double digits, the CPI has the potential to surge further. Before the new government’s energy price cap plan is put into action, it will be instructive to note how far the existing trend can go. The CPI is fed by the PPI which comes in two shapes: input and output. In addition, the core CPI (excluding energy, food, alcohol and tobacco) will identify the areas of sticky inflation vs. those that can be reversed easily. If the difference between headline and core increases, this could point towards energy being the dominant factor behind prices, whereas if that difference falls, it could mean that inflation is spreading throughout the British economy, something that the energy price cap policy cannot do much about.
Thursday: Chinese statistics for August
Our thoughts: no country elicits more scepticism than China when it comes to data. Many market participants believe that China is headed for a major slowdown, like the rest of the world, despite the command control of the economy and the country being at a different stage in its cycle. Last month, the usual data scared many investors, who saw red flags for growth. Those red flags seemed to be confirmed by later cuts in interest rates by the People’s Bank of China. It is well known that the Chinese property sector is in a slump, but other parts of the economy have held up fairly well so far (industrial production, retail sales, investment and employment). Will they continue to do so, in light of the significant drop in inflation registered recently? Do lower price rises signify an improvement in supply chains, or a major growth shortfall?
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Hawkish messages and hawkish actions from central banks
The European Central Bank (ECB) hiked interest rates by a historic 0.75% and pledged ‘several’ further increases. This brought the ECB deposit facility rate to 0.75%, with the main refinancing rate at 1.2% and the marginal lending facility at 1.5%.
President Christine Lagarde commented: “This major step front-loads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target. Over the next several meetings the Governing Council expects to raise interest rates further.” The decision was unanimous, but Lagarde said that 75 bps wasn’t ‘the norm.’
The ECB raised its outlook for inflation this year and next, while slashing its forecast for economic expansion in 2023. The 0.9% projection for growth next year is still more optimistic than market estimates. Lagarde reiterated that the ECB doesn’t target a specific exchange rate but said it’s ‘very attentive’ to the situation around the currency.
Fed Vice Chair Lael Brainard reinforced the Fed’s message on inflation, saying “while we have no control over the supply shocks to food, energy, labour, or semiconductors, we have both the capacity and the responsibility to maintain anchored inflation expectations and price stability… We are in this for as long as it takes to get inflation down.”
Fed Chair Jay Powell reiterated his hawkish message on rate rises and did not wish to dispel expectations of a third 75 bp hike in 10 days, saying the Fed needs to act ‘forthrightly’ to make sure high inflation does not become entrenched.
Two more Fed officials added their voices to the need for higher rates to tame inflation: former New York President Fed Bill Dudley and Governor Christopher Waller.
The Bank of Canada also hiked by 75 bps and the expectation in markets is now that the Fed will also raise rates by 75 bps at its 21 September meeting.
The Bank of England’s Monetary Policy Committee delayed its next interest rate decision meeting to 22 September on account of the mourning period in the UK.
Surprising strength in services survey. Have jobless claims lost their uptrend?
Surveys: the ISM (Institute for Supply Management) non-manufacturing PMI climbed for the second month, to 56.9. The most notable details were new orders at 61.8 and business activity at 60.9, which were the strongest this year.
Supplier deliveries fell to a 30-month low of 54.5, indicating some easing of supply chain issues. Likewise, the price index eased for the fourth month since reaching a record-high 84.6 in April, dropping to a 19-month low of 71.5 in August.
Housing: mortgage rates in the US climbed for the third week in a row, reaching the highest level since 2008. The average for a 30-year loan increased to 5.89%, up from 5.66% the previous week. Mortgage Bankers Association (MBA) mortgage applications fell 0.8% after -3.7% the previous week.
Trade: the US trade balance for July improved from US$80.9bn to US$70.6bn.
Sales: wholesale trade sales fell 1.4% in July.
Credit: consumer credit in July fell from US$39bn to US$23.8bn.
Employment: jobless claims continued their countertrend move downward, with initial claims falling again from 228K to 222K but continuing claims rising from 1437K to 1473K.
Housing weaker but the rest of the economy is not obviously suffering now
Auto industry: new car registrations in August recovered, rising 1.2% year-on-year, following -9.0% the previous month.
Retail: the British Retail Consortium (BRC) like-for-like sales rose 0.5% year-on-year, down from 1.6% previously.
Surveys: there was a small improvement in the S&P Global/CIPS construction PMI from 48.9 to 49.2, although it is still in contraction territory.
Housing: the Royal Institute of Chartered Surveyors (RICS) house price balance weakened considerably from 62% to 53%.
Employment: UK job vacancies grew in August at the slowest pace in 18 months, according to a KPMG and Recruitment & Employment Confederation report, with responses from a panel of about 400 UK recruitment and employment consultancies. The report also showed the softest increase in starting salaries since June 2021.
Growth: July GDP was up 0.2% after a negative June, driven by services rising 0.4%, with manufacturing production barely up, with +0.1%, and construction output falling an unexpected 0.8%. The trade deficit was a little better at £19.4bn vs. £22.8bn. Year-on-year, construction remains the strongest contributor at 4.3% vs. 1.1% for manufacturing.
Some very weak numbers recently
Surveys: the eurozone Sentix investor confidence slumped further from -25.2 to -31.8.
Retail: July retail sales in the eurozone recovered from -1.0% to +0.3%.
Industry: German factory orders dropped 1.1% in July after a prior -0.3% fall. Likewise, German industrial production was down 0.3% in July from +0.8% the previous month. French industrial production was even more negative, down 1.6% in July down from +1.2%.
Growth: Q2 GDP growth was revised upward from 0.6% to 0.8%, with a strong showing from household consumption and employment.
China trade slowing, Chinese inflation moderate, machine tools doing better and Japanese surveys higher
China: exports slowed from 18.0% year-on-year growth to 7.1% in August, with imports down to 0.3% from 2.3%. Once again, Chinese inflation defied the rest of the world, with the CPI down from 2.7% to 2.5% and, more crucially for the world, the PPI down sharply from 4.2% to 2.3%. Money supply was fairly steady in August, with M0 up 14.3% year-on-year from 13.9% the previous month, M1 down from 6.7% to 6.1% and M2 up from 12.0% to 12.2%.
Japan: July household spending was slightly softer, up 3.4% year-on-year from 3.5%. Labour cash earnings also eased from 2.0% to 1.8%.
The Leading Index CI fell from 100.3 to 99.6 whereas the Coincident Index increased from 99.2 to 100.6. The Eco Watchers Survey was better, with the current index up from 43.8 to 45.5 and the outlook surging from 42.8 to 49.4.
Money supply growth was unchanged, with the money stock M2 at 3.4% and M3 at 3.0%.
Q2 GDP was upgraded from 0.5% to 0.9%.
Machine tool orders for August rebounded, rising 10.7% year-on-year from 5.5% the previous month.
Not much help from OPEC+ on oil output
OPEC+ announced a very small oil production cut of 100,000 barrels per day to bolster prices. The G7 countries agreed to cap Russian oil prices to reduce funds flowing into Moscow’s war chest and bring down the cost of oil for consumers.
After dipping below US$90/bbl, Brent oil recovered at the end of the week to finish broadly unchanged.
In the Commodity Research Bureau index (CRB), all commodities and raw industrial spot price indices have fallen 10% and 11%, respectively, from their peak in June, confirming the weaker the global economy. During the past week, however, industrial metal prices recovered, with copper up almost 3%.