The numbers for the week – 13 Mar 23
Markets last week
The week was bookended by drama in the US. First, US Federal Reserve (Fed) Chair Jay Powell testified in front of both houses of the US Congress and delivered his most hawkish outlook yet, despite not sounding exactly consistent on both days. Markets then assumed a possible 50 basis point (bp) hike at the next Fed meeting instead of 25 bps. The middle of the week therefore saw Federal funds futures forecasting a rate of 5.50-5.75% by September this year. 10-year US treasury yields climbed to 4%, 2-year yields topped 5%, and global bond yields surged in sympathy.
At the end of the week, SVB Financial Group (also known as Silicon Valley Bank), a major lender to venture capital firms, sold equity to shore up its capital position (and was later closed by the California regulator). As this came immediately after the crypto bank Silvergate shutdown, it led to significant concerns about US banks and even global banks and was the main cause of a reversal in risk appetite. As a result, bond yields collapsed, with the US 10-years down to 3.70%, the 2-years at 4.59% (almost 50 bps down from its intra-week high), and European and UK bond yields also falling heavily. US inflation breakevens (future inflation expected over the period) also slumped, down to 2.83% for 2-years (from 3.38% a week ago). In fact, therefore, the huge increase in bond yields after Chair Powell’s communications to the US Congress was more than entirely reversed at the end of the week after the SVB failure.
This two-act drama was followed by a third act on Friday, when the US employment report for February was published. Although the headline jobs creation (311,000) was the 11th estimate-beater in a row, the underlying details showed higher unemployment rates and less earnings growth, which is presumed to be less inflationary but failed to support risk markets for more than half a day.
In contrast to this drama, Bank of Japan (BoJ) Governor Kuroda did not make any changes to interest rate policy and yield curve control in his last meeting, triggering drops in the Japanese yen and Asian markets in general but helping Japanese shares.
Economically, China’s 5% growth target was accompanied by lower consumer and producer inflation. The very mild winter experienced in Europe as well as North America seems to have had an impact on the economy, in addition to the better energy picture. The construction sector in the UK and Germany had exceptionally buoyant surveys as a result. In the US, a few changes to employment statistics seemed to show a less tight market, with jobless claims exceeding 200,000 for the first time since early January, but the limited job-shedding is reflecting the unwillingness of companies to part with excess labour in case of a better recovery.
Slowly but surely, economic data in the UK has been looking less gloomy and the unexpectedly positive January GDP growth boosted sterling, although it was mostly the US dollar behind the moves. Collateral changes to the markets from all the movements quoted above led to a weaker US dollar, a marked rebound in the gold price, drops in other commodities and a risk-off week for equities globally.
At the end of this momentous week, long-term government bond yields had fallen by 20-25 bps globally, but the short end had dropped much more in the expectation of central bank reactions to any potential banking spillover from SVB. Federal funds futures slumped, projecting 35 bps less of hikes in the next few months and then a cut from the Fed in Q4 2023 by some 40 bps as well.
Equities were sold wholesale on Thursday and Friday, leading to a poor week, in particular for US and Hong Kong shares. Bucking the trend, the Japanese market actually managed to eke out a positive return. The worst hit sectors were unsurprisingly financials, down more than 6% on the week, but also real estate, materials, energy and technology, with defensive utilities and consumer staples as the safer areas.
The week ahead
Monday and Tuesday: US Consumer Price Index (CPI) and Producer Price Index (PPI)
Our thoughts: once again, US inflation will be top of mind for investors. A further fall in the CPI is expected but the core CPI (ex food and energy) could be stickier. The same is expected for the PPI, which could see a drop in the headline reading but a less pronounced reduction in the core number. Most market analysts will not be content to look at these numbers only but will drill down into the sub-categories of inflation, with a focus on services inflation, particularly ex shelter. Also, used cars seem to have had undue importance in past numbers and could move the data in the other direction soon. The devil could be in the details.
Wednesday: UK budget
Our thoughts: budgets are easy to dismiss by investors as political exercises, but they can nevertheless exert an influence on some major economic data. The current government has taken over at a time of market crisis and had to deal with a difficult legacy. At the same time, some room for manoeuvre seems to have been found in the public finances recently, so the question is how much will be used and how much put away for a rainy day. It is clear that the Bank of England will try and take fiscal policy into consideration when deciding on future interest rate moves, so the budget will matter for rates as well.
Thursday: European Central Bank (ECB) meeting
Our thoughts: another 50 bp rate hike is almost baked in the cake for the ECB this week (despite the SVB problem) but the question is what will come next and how far will they go. Unlike the US, where Fed officials speak profusely, ECB officials tend to intervene less often. The latest comments have come from the hawkish end of the ECB and the question is whether the market is getting the right ‘colour’ on how far the ECB is willing to go. President Christine Lagarde is smack in the middle of the dove-hawk spectrum and hence her views are more relevant, but they have not been expressed recently. The ECB can influence global markets not only through its rate hikes and terminal rate but also through its quantitative tightening (QT) – the sale of existing European bond market assets. At a time of possible change in the Bank of Japan (the other traditionally conservative central bank), what the ECB does in QT could be very meaningful for global liquidity.
The numbers for the week
Central banks/fiscal policy
Fed Chair moved markets to expect a higher interest rate hike, but his two days before Congress sounded different
Fed Chair Jay Powell spoke to the US Congress over two days last week: Tuesday in front of the Senate and Wednesday with the House of Representatives. He was generally acknowledged to be more hawkish than in previous communications, although there was a difference in tone between both days. “There is little sign of disinflation thus far in the category of core services excluding housing, which accounts for more than half of core consumer expenditures. To restore price stability, we will need to see lower inflation in this sector, and there will very likely be some softening in labour market conditions… Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy… If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.”
The market reaction was clear. The US Federal funds futures increased by almost the equivalent of one 25 bp hike to a ‘terminal’ rate of 5.63% by September 2023 with one 25 bp cut priced in by January 2024. A small drop in the US breakeven rates (future expected inflation) for the one-year and two-year inflation showed that the market expects the higher Fed funds rate to have a bigger impact on inflation reduction.
The Bank of England’s (BoE) former chief economist, Andy Haldane, warned that the BoE now faces the “hardest yards” in reducing inflation to 2%. “Given the amount of tightening already in the system from last year, and given the flickerings of growth from a low base, I’d be going cautiously just at the moment before embarking on a further round of sharp tightening certainly… As we’ve found previously through the 70s, 80s and maybe parts of the early 90s, the hardest yards are probably grinding down from the four to the three to the two,” he said, referring to the inflation rate.
Current BoE official Catherine Mann said the pound could weaken further based on central banks’ relative interest rate movements. “There has been a quite a hawkish tone coming from the Federal Reserve and ECB… An important question in regard to the pound is how much of that existing hawkish tone is already priced into the pound. If Fed hawkishness is not priced in, the pound could fall further.”
The European Central Bank (ECB) published consumers’ expectations for inflation over the next 12 months, which are lower, in particular for three years ahead. Inflation expectations for the next 12 months fell to 4.9% in January from 5% and for three years ahead they dropped to 2.5% from 3%.
BoJ Governor Haruhiko Kuroda kept everything unchanged (interest rates, yield curve control) in his swansong meeting. As a result, the Japanese yen tumbled, 10-year Japanese Government Bond yields fell 11 bps below the 50 bp ceiling set by the BoJ. The next BoJ meeting, under new Governor Kazuo Ueda, takes place on 28th April.
United States
Employment market is still very tight, regardless of the optimistic interpretations on the February payroll report
Industry and trade: factory orders fell 1.6% in January after a positive +1.7% previously, although ex transportation, they were up 1.2%. Wholesale trade sales rose 1.0% in January, up from -0.2%.
Housing: Mortgage Bankers Association (MBA) mortgage applications rose 7.4%, from -5.9% the prior week.
Employment: the Job Openings and Labour Turnover Survey (JOLTS) job openings fell by half a million from 11.234m to 10.824m, but the new number was higher than expected and the previous one was revised upward. The job cuts reported in the Challenger, Gray & Christmas report were slightly lower at 410% in February vs. 440% the previous month (a decrease in job cuts means more jobs).
Jobless claims, however, registered the first week above 200K since the beginning of January, at 211K from 190K for the initial claims and 1718K vs. 1649K for the continuing claims. The increase probably reflected the high-profile layoffs, especially in the technology sector, announced at the beginning of the year. For reference, the all-time low in this series was in March 2022 at 166K, whereas the high (excluding the pandemic period) was 660K in March 2009.
The February employment report was mixed. The headline non-farm payroll creation was very strong at 311K, with minor downward revisions to the two previous months.
Most of the new jobs came from private payrolls, up 265K, with manufacturing actually negative at -4K. The details looked less strong than the headline, though. The unemployment rate (U-3) ticked up from 3.4% to 3.6%, driven a higher labour force participation rate of 62.5% vs. 62.4%, and the underemployment rate (U-6) also rose from 6.6% to 6.8%. Although average hourly earnings rose from 4.4% to 4.6%, that was below consensus, and the average weekly hours worked by all employees, eased down from 34.6 to 34.5, altogether being seen as less inflation-inducing than the sheer new jobs headline.
United Kingdom
Better growth in January
Industry: new car registrations were much stronger in February, up 26.2% year-on-year vs. 14.7% previously.
Surveys: the S&P Global/CIPS construction Purchasing Managers’ Index (PMI) bounced back hard from 48.4 to 54.6, way above expectations.
Retail: the British Retail Consortium (BRC) sales like-for-like rose from 3.9% year-on-year to 4.9% in February.
Housing: the Royal Institute of Chartered Surveyors (RICS) house price balance was a smidge better than estimates at -48%, although it was still down from the prior month.
Growth: GDP was better than expected, up 0.3% for January with the three months/three months flat, up from -0.3%. The manufacturing sector was negative in January, -0.4% and construction went down 1.7% (probably due to the strikes rather than the weather), but services were up 0.5% and the trade balance improved.
Europe
Germany looking a bit better
Surveys: the Sentix investor confidence index in the eurozone worsened from -8.0 to -11.1. The German S&P Global construction PMI rose sharply from 43.3 to 48.6.
Retail: Eurozone retail sales in January rose 0.3%, below estimates, although the previous negative month was revised upwards.
Industry: German industrial production improved somewhat from -3.3% year-on-year to -1.6% in January. German factory orders were up 1.0% in January, but retail sales fell 0.3%.
China/India/Japan/Asia
Chinese inflation down and Japanese PPI also softer
China: exports were less bad than expected. The year-on-year growth was -6.8% (in US dollars), better than estimates. Imports, however, disappointed, down 10.2% year-on-year, showing that Chinese consumption has not quite fully recovered. As a result, foreign exchange reserves were cut by some US$50bn to US$3,133bn, still comfortably the largest reserves in the world.
Inflation was better behaved, with the CPI down from 2.1% to an enviable 1.0% and the PPI down further from -0.8% to -1.4%. The PPI matters for global importers of Chinese manufactured products.
Japan: labour cash earnings fell from 4.1% year-on-year to 0.8%. Surveys were mixed: the leading index eased from 96.9 to 96.5, the coincident index had a bigger fall from 99.1 to 96.1, but the Eco Watchers surveys were much higher, with the current survey jumping from 48.5 to 52.0 and the outlook from 49.3 to 50.8.
The manufacturing bellwether machine tool orders were worse, at -10.7% year-on-year in February vs. -9.7% previously.
The PPI fell from 9.5% to 8.2%, also a positive for the global economy.
Oil/Commodities/Emerging Markets
Gold stars above all others
Gold surged above all other commodities as one of the ultimate risk havens. Investors seeking some protection against potential bank problems boosted the bullion price on Friday to US$1,868/oz. It was announced during the week that China had bought more than 100 tonnes of the yellow metal over the last four months, which obviously supported sentiment in addition to the SVB issue.
With a fairly flat US dollar at the end of the week, despite huge intra-week movements, oil and industrial metals corrected in line with a risk-off week.
