Markets last week
‘Churning’ is the word that comes to mind when looking at financial markets last week, with sharp daily movements in reaction to events and data, ultimately without much direction. The events that triggered those moves were varied. China disappointed two days in a row, with negative consumer inflation for the first time since February 2021 and then slumping exports and imports. The Italian government announced a windfall tax on bank profits and partly backtracked on it the next day. The US rating agency, Moody’s Investor Services, downgraded the debt of many US banks.
On the positive side, US inflation was seen as well-behaved later in the week, despite still being too high for the taste of the US Federal Reserve (Fed). The UK economy grew much faster than expected in June and hence during the second quarter.
Additionally, oil prices bounced back on continued supply discipline from Saudi Arabia, but also the escalation of the Ukraine-Russia conflict to Black Sea shipping. Surprisingly, European natural gas prices soared on the back of a strike in Australian LNG (Liquid Natural Gas) facilities, putting price pressure on different sources of energy.
Markets were not sufficiently driven by fundamentals to be impervious to this see-saw of news items. The next meeting of the Fed is more than a month away and, although the expectation for further hikes has been shrinking, there weren’t enough comments from Fed officials to set market participants straight on interest rates. US economic growth continues to power ahead, with the latest estimate from the Atlanta Fed at 4.1% for the current quarter. With the UK clearly stronger than expected and Europe less negative, only the weak Chinese economy stands in the way of global economic strength, so investors were not too clear on whether to take more risks.
The backdrop, however, was for higher government bond yields as a corollary to better growth and sticky inflation. The UK GDP surprise drove gilt yields much higher, up 15 bps on the week, but other bond markets joined in. At the end of the week, US treasury yields had also climbed by 12 bps and German yields by 6 bps. Interestingly, this seemingly unstoppable rise in bond yields has coincided with lower interest rate hike expectations from the central banks, with Fed rates now seen not moving much higher, and Bank of England (BoE) rates not exceeding 5.75% from the current 5.25%.
This in turn helped support the US dollar, which is normally negative for commodities, but the oil price took a life of its own due to supply constraints.
Quite logically, therefore, the energy sector was the star within stock market sectors, in particular contrast to information technology, whose year-to-date leadership is starting to come into question. Unusually against that context, healthcare also starred, due to a flurry of news on weight-loss drugs supporting various shares in the sector. Regionally, the US was more resilient and China more negative.
The week ahead
Tuesday: July Chinese economic data
Our thoughts: there is no doubt that Chinese growth has disappointed this year. The question is, therefore, by how much. The expectation that authorities will stimulate their economy has been espoused on and off by markets for most of the year, but so far has been let down by the facts. In that respect, looking at the detailed growth rates for retail sales, industrial production, investment, and property sales could reassure investors of a better path ahead, or further confirm the Chinese downturn.
Wednesday: UK inflation
Our thoughts: how long will the UK be the outlier on inflation compared to other G-7 countries? Even as the US is back to 3-4%, our current rates are still way too high and place the BoE in an unenviable conundrum dealing with poor growth, high price rises and punitive mortgage rates. A significant drop in consumer price indices would obviously make a big difference, but only if it is seen as sustainable by the BoE. The UK seems to have the same issue as the US of a falling headline inflation number, mostly due to energy, and a sticky core inflation reading caused by the tight employment market. Will that tricky equation be helped this week, particularly in light of the upside on economic growth?
Wednesday: July Fed meeting minutes
Our thoughts: will the markets forget about central banks and concentrate on the real economy? It may be premature to think so, and chances are the minutes from the July meeting of the Fed will still be parsed to death by market participants for possible clues about the September meeting ahead. Although Federal Funds futures have downgraded the probability of a further Fed rate hike in September, this opinion may easily be reversed based on data, but also on account of the detailed conversation emanating from the July meeting minutes.
The numbers for the week
Central banks/fiscal policy
Different opinions within the US central bank
Fed Governor Michelle Bowman said that she expects additional interest rate increases to be needed: “I will also be watching for signs of slowing in consumer spending and signs that labour market conditions are loosening”.
Philadelphia Fed President Patrick Harker suggested that the Fed’s rate rises might be coming to an end soon: “I believe we may be at the point where we can be patient and hold rates steady and let the monetary policy actions we have taken do their work.”
San Francisco Fed President Mary Daly said that the Fed has “more work to do” to get inflation down to the 2% target and that it is premature to assume that the Fed has done enough on interest rates, despite inflation “moving in the right direction”.
No sharp changes in the numbers from previous data, except for jobless claims climbing again. Is it real this time?
Surveys: the NFIB (National Federation of Independent Business) small business optimism index edged up from 91.0 to 91.9.
The bellwether University of Michigan sentiment index was fairly flat at 71.2 vs. 71.6, with current conditions up from 76.6 to 77.4, but expectations down from 68.3 to 67.3.
Housing: MBA (Mortgage Bankers Association) mortgage applications fell 3.1% in the week ending 4 August, after a similar drop the previous week.
Employment: jobless claims spiked back up, with initial claims rising from 227K to 248K, but continuing claims down from 1692K to 1684K.
Inflation: the widely awaited CPI (consumer price index) was a little higher for the headline number, at 3.2% vs. 3.0%, driven by a small pick-up in energy prices, but down for the core reading (ex. food and energy) from 4.8% to 4.7%. Real average hourly earnings rose 1.1% year-on-year from 1.3%. The PPI (producer price index) increased year-on-year with the PPI final demand number up 0.8% from 0.2%, the PPI ex. food and energy unchanged at 2.4%, and the PPI ex. food, energy, and trade unchanged at 2.7%.
Inflation expectations embedded within the University of Michigan survey improved for one-year inflation, at 3.3% vs. 3.4%, and 2.9% vs. 3.0% for five-to-ten-year inflation.
Upside surprise in growth clashes with softer data like sales and housing
Consumer: the BRC (British Retail Consortium) sales like-for-like rose 1.8% year-on-year in July, down from 4.2% the prior month.
Housing: the RICS (Royal Institute of Chartered Surveyors) house price balance fell further from -48% to -53%.
Growth: Q2 GDP growth was better than expected, up 0.2% from Q1, the best quarterly return in over a year, after the June growth data surprised on the upside at 0.5%. The details were also quite positive, with manufacturing and construction output stronger in June (up 2.4% and 1.6% respectively), but also private consumption up 0.7% during the quarter, and government spending increasing 3.1%. The index of services was rather subdued during June, up only 0.2%.
Very few data points
Surveys: the eurozone Sentix investor confidence improved from -22.5 to -18.9.
Inflation: consumer expectations for euro-area inflation fell from 3.9% to 3.4% in June, in the monthly survey published by the ECB (European Central Bank). For the longer term, the three-year expectation fell from 2.5% to 2.3%.
China is ailing, as highlighted by deflation and slumping trade. Japan generally looking much better
China: China went into deflation for the first time since February 2021, with the CPI falling from 0.0% to -0.3%, whilst the PPI was slightly less negative, at -4.4% vs. -5.4%.
Both exports and imports disappointed in July. Exports fell 14.5% year-on-year, from -12.4% previously, and imports dropped 12.4% down from -6.8%.
The level of foreign exchange reserves increased slightly, from US$3,193bn to US$3,204bn. Money supply fell somewhat, with M2 down from 11.3% year-on-year to 10.7%, M1 down from 3.1% to 2.3% but M0 up from 9.8% to 9.9%.
Japan: household spending in June was down -4.2% year-on-year, little changed from the prior month at -4.0%. Labour cash earnings eased from 2.9% to 2.3%.
The Eco Watchers surveys were better, with the current survey up from 53.6 to 54.4 and the outlook rising from 52.8 to 54.1.
Money stock was a tad lighter, with money stock M2 up 2.4% year-on-year, from 2.6% previously, and money stock M3 up 1.9%, from 2.1%.
The widely followed machine tool orders, which act as a bellwether for global manufacturing, had a small improvement from -21.2% year-on-year to -19.8%.
The PPI fell from 4.3% year-on-year to 3.6% in July, slightly above estimates.
Energy prices rising again
The potential escalation of the Ukraine-Russia conflict on the Black Sea was supportive of oil prices, with the US crude gauge, WTI, setting a high for the year above US$84/bbl and close to last summer’s levels. Also, crude oil inventories rose 5.85 million barrels, as per the Energy Information Administration. OPEC data suggest a two-million-barrel supply deficit, another announcement that supported oil prices.
European natural gas prices surged as much as 40% on LNG supply restrictions from Australia.