Markets last week
Last week we saw a less bullish week in markets, with a round trip on risk appetite. The highlight of the week was an interview of US Federal Reserve (Fed) Chair Jay Powell on Tuesday. On the face of it, Mr. Powell reiterated the same message of unbending fight against inflation, saying that the Fed would raise rates another couple of times and leave them there for a long time, and acknowledging that the inflation battle would not be won this year. The hawkish tilt was again interpreted differently by markets, with equities soaring during his comments, although government bonds did not take the same side, with Federal fund futures moving closer to the Fed’s expectations on interest rates.
The Fed’s more hawkish tone was not only repeated by many other Fed officials during the week, but also by European Central Bank Executive Board member Isabel Schnabel, and echoed by other world central banks, with Mexico and Sweden surprising rate markets on the upside. Interestingly, the central bank change that stirred markets the most was the appointment of Kazuo Ueda as Governor of the Bank of Japan (BoJ), as there are expectations that he might alter BoJ policy, which is currently the easiest of all major central banks.
Very few meaningful statistics guided markets. The UK just dodged a recession, Chinese inflation was well behaved (notably producer prices which feed into global imports), and US jobless claims were still close to their all-time lows. The dearth of market-moving data left the field open for investors to position themselves on the basis of Fed expectations. As a result, in the latter part of the week, equity leadership switched back from technology, which enjoyed significant short covering this year, to last year’s favourite: energy.
Once again, there was huge volatility in government bonds and yields ended up much higher, particularly gilt yields. The US dollar staged a small recovery from its recent fall, stopping certain commodity prices from rising, but crude oil was unabated, surging on a combination of Chinese demand and Russian output cuts.
At the end of the week, government bond yields rose by 34 bps for the 10-year gilt and 21 bps for the equivalent US treasury bond. The US dollar rallied mostly against the euro whilst sterling was quite solid. Oil prices soared over 8% whereas copper fell prey to some correction after recent strength due to turmoil in the mining industry in Peru and Chile.
Chinese markets took a breather, in part due to the downing of a Chinese balloon by the US, which raised the spectre of geopolitical tension again. In equities, Europe and Asia fared worst, down more than 2%, while the US fell 1% and the best markets were Japan and the FTSE 100. The worst areas were the technology complex, materials, real estate and consumer staples, with energy the only positive sector for the week, up nearly 5%.
The week ahead
Tuesday: US CPI
Our thoughts: once again, one theme matters for markets next week and this time it will be inflation prints. Although the Consumer Price Index (CPI) is not the gauge followed by the Fed, it is nevertheless the measurement that most investors consider when discussing inflation. The headline as well as the core ex food and energy are both expected to keep falling but more moderately, following an actual monthly drop for December. As usual, the devil will be in the details, namely how much of inflation is generated by energy or industrial goods benefitting from lower commodity prices vs how much is still dependent on services inflation driven by a tight labour market.
Wednesday: UK inflation
Our thoughts: on paper, the UK should have similar issues to the US, but there are some significant differences: the absolute level is much higher in the UK (still expected to be in double digits), energy is a peskier input due to the country’s dependence on gas, the government’s support for energy consumers somewhat interferes with the analysis of inflation data, and the Bank of England is lagging the Fed in its rate-hiking cycle, which means the impact of monetary policy on inflation should be felt later in the year. The expectations are for a much smaller fall than in the US, both for the CPI as well as for the different versions of Producer Price Index (PPI): PPI input and PPI output.
Thursday: US PPI
Our thoughts: the PPI also has a big impact on markets, as it typically is an indicator of future trends in the CPI. As a result, we are seeing expectations that further falls in producer prices would benefit consumer prices later on, although the equation is not quite so straightforward. Larger drops in PPI are expected compared to the CPI moves. The US PPI has three different variants: final demand, ex food and energy, and ex food, energy, and trade. The subtleties between the three readings will give analysts plenty of opportunities for commentary.
The numbers for the week
Central banks/fiscal policy
Fed message rehashed but markets not heeding. Bank of Japan Governor appointment
In an interview on Tuesday, Fed Chair Jerome Powell reiterated his message that interest rates need to keep rising to beat inflation. He stated that rates might have to move higher than expected. Equities seemed to be unperturbed by the hawkish message and registered a strong advance as he spoke.
Minneapolis Fed President Neel Kashkari said that January’s strong labour market report shows that the Fed needs to keep hiking. Atlanta Fed President Raphael Bostic said January’s strong jobs report means the Fed might need to hike to a higher peak than previously expected, and that if a stronger economy persists, “it’ll probably mean we have to do a little more work and I would expect that that would translate into us raising interest rates more than I have projected right now.”
New York Fed President John Williams said the Fed will vote on “a couple of more rate hikes to get to that level we think is appropriately restrictive” and then keep the rate there until inflation falls to 2.0%. “So if we continue to get, for example, strong labour market reports or higher inflation reports, it may well be the case that we have do more and raise rates more than is priced in. My guess is it will take certainly into not just this year, but next year to get down close to 2%.”
Other interventions went in the same direction. Fed Governor Lisa Cook: “We are not done yet with raising interest rates, and we will need to keep interest rates sufficiently restrictive”. Fed Governor Christopher Waller: “It might be a long fight, with interest rates higher for longer than some are currently expecting”. Richmond Fed President Thomas Barkin: the Fed needs to “stay the course” in its inflation fight.
Japanese media reported that the Government had picked Kazuo Ueda as the next Governor of the Bank of Japan (BoJ) to replace outgoing Haruhiko Kuroda in April, apparently after the front-runner turned down the role. This surprise choice was seen as hawkish against a backdrop of surging wages in Japan and drove the yen up more than 1%, but the currency gave up its gains after Mr. Ueda said that easy monetary policy was still warranted.
Few numbers last week. Jobless claims still minimal and inflation expectations rising
Surveys: the University of Michigan sentiment index recovered to a year-high of 66.4 from 64.9, above estimates, with current conditions up to 72.6 from 68.4 and expectations a little below from 62.7 to 62.3. The inflation forecasts embedded within the survey rose significantly for the one-year inflation reading to 4.2% from 3.9% but remained at 2.9% for the five-to-ten-year inflation level.
Housing: MBA mortgage applications bounced back for the week from -9.0% to +7.4%. It is not clear whether this is due to the recent fall in mortgage rates.
Trade: the trade deficit worsened from US$61bn to US$67.4bn in December.
Employment: jobless claims recovered a little from their ultra-low levels. Initial claims rose from 183K to 196K and continuing claims from 1650K to 1688K.
Dodged a recession with 0% GDP in Q4
Housing and building: the Royal Institute of Chartered Surveyors (RICS) house price balance dropped to -47% from -42%. The S&P Global/CIPS UK Construction Purchasing Managers’ Index (PMI) eased from 48.8 to 48.4.
Growth: GDP fell by 0.5% in December, driven by a large drop in services but flat manufacturing and construction, for an unchanged Q4 overall after a negative -0.3% in Q3, which means that the UK just avoided the technical definition of a recession.
Industry: new car registrations were softer, up 14.7% year-on-year in January vs. 18.3% previously.
Retail: the British Retail Consortium (BRC) sales like-for-like fell from 6.5% year-on-year to 3.9% in January.
Generally better but mixed data
Surveys: the Sentix eurozone investor confidence index improved from -17.5 to -8.0.
Sales: eurozone retail sales fell sharply in December, down 2.7%, vs a positive +1.2% the prior month.
Industry: German factory orders rose 3.2% in December, up from -4.4%. The German construction PMI recovered somewhat, from 41.7 to 43.3.
Inflation: German inflation surprised on the downside, with the EU harmonised CPI at 9.2%, down from 9.6%.
Chinese inflation rising but still way below western levels, with producer prices not likely to damage the rest of the world at this stage
China: the CPI rose from 1.8% to 2.1%, with core inflation excluding food and energy up to 1%, the highest level since June. The headline CPI increase was driven by higher food prices and services. The PPI, however, fell 0.8%, below estimates, due to softer commodity prices.
Foreign exchange reserves continued to pile up, rising from US$3,128bn to US$3,184bn, still by far the largest foreign exchange reserves in the world. Money supply increased, with M2 up 12.6% year-on-year in January, up from 11.8%, and M1 up to 6.7% from 3.7%, but M0 (only notes and coins in circulation) falling from 15.3% to 7.9%, presumably due to the reopening of the economy.
Japan: machine tools orders were down 9.7% year-on-year from a positive number last month, meaning that global manufacturing is weakening further.
Labour cash earnings picked up significantly, up 4.8% year-on-year in December, vs 1.9% previously. Household spending fell 1.3% in December, in line with the previous month.
Surveys were mixed. The Eco Watchers survey was weaker for the current reading, at 48.5 vs. 48.7, whereas the outlook jumped from 46.8 to 49.3. The leading index eased from 97.7 to 97.2 with the coincident index rising from 99.3 to 98.9.
Oil surge probably due to output cuts
There was a sharp recovery in oil prices, which may have been due to the anticipation of the 500,000 barrels/day Russian crude cut, together with cuts in Norway, Azerbaijan and Kazakhstan. Industrial metals were more subdued. Copper corrected after a strong run driven by turmoil in the mining areas of Peru and Chile. The strength in the US dollar also had a dampening effect on most commodity prices, but gold managed to stay flat over the week.