Markets last week
The week was dominated by US inflation readings and the market reaction to them. The US CPI (consumer price index) fell from 9.1% to 8.5% and the PPI (producer price index) dropped from 11.3% to 9.8%. Although in both cases the fall in energy prices over the previous month was almost entirely responsible for the softer print, markets were buoyed by the prospect of inflation having peaked. This was in keeping with previous moves in bond and equity markets anticipating a future reduction in US interest rates during 2023.
It is once again interesting that government bonds had a more subdued reaction than shares, in particular the technology sector. The US 10-year treasury yield fell briefly after the announcement of the lower CPI level, but quickly recovered and ended the week where it started. Equities, however, took the lower inflation print more seriously, with the US market driving returns in expectation of lower rates from the US Federal Reserve (Fed).
Other data during the week were mixed. Surveys rebounded somewhat in the US (University of Michigan) and in the eurozone (Sentix); UK economic growth disappointed in June and hence for the second quarter (Q2) as well; Japanese machine tool orders weakened in a sign that manufacturing is slowing down; but the significant number which investors seemed to ignore was the second consecutive quarter of large negative productivity in the US, clawing back all the progress made since COVID-19.
Over the weekend, Chinese data softened, and the People’s Bank of China (PBoC) cut its medium-term lending facility rate by 10 bps.
Against that backdrop of economic slowdown and lower rate expectations, another four senior Fed members reiterated their views on monetary policy, stressing the need for further interest rate hikes to bring inflation down and ruling out cuts next year.
Now that we are at the tail-end of the Q2 reporting season, we note that equity analysts have been progressively reducing their earnings estimates for this year and next for most sectors, with the exception of energy, utilities and real estate.
Over the week, stock markets continued their positive run from the 16 June bottom. The surprise outperformer was Japan with China and Hong Kong lagging, although the US market overtook Japan on Friday with a strong session. The best sectors were energy, financials and materials, with healthcare and consumer staples the worst.
The US dollar had its biggest fall in two months when the US CPI was published but bounced back thereafter.
Oil prices once again recovered from their previous drop with Brent flirting with the US$100/bbl level but finishing the week around US$98. The gold price recovery fizzled at the US$1,800 level for the second time, but copper easily cleared the US$8,000 threshold again.
Government bond yields fluctuated, but the US ended up stable with UK and European rates rising a few basis points.
The week ahead
Tuesday: ZEW (Zentrum für Europäische Wirtschaftsforschung) surveys in Germany and the eurozone
Our thoughts: the eurozone, and in particular Germany, is suffering from soaring energy prices due to the Ukraine war and Russian sanctions. This has led to slumping surveys, with the ZEW expectations for Germany at a decade low, although the current situation is still marginally above the COVID-19 low. ZEW also publishes a eurozone-wide expectations survey and the last one was also at a decade low. It may matter to the markets whether there is a recovery this week or a further drop, given the widely-held expectation of a recession in Europe.
Wednesday: UK July inflation (CPI, RPI, PPI)
Our thoughts: the Bank of England 10 days ago did not shy away from giving us the bad news about inflation, forecasting a peak at 13% later this year. We have the opportunity for a ’progress report’ this week with the July CPI, PPI and RPI (retail price index). Economists are expecting an increase in the CPI (including core CPI ex food and energy) and the RPI, although the PPI output (factory gate prices) and PPI input (raw or intermediate inputs) are seen peaking at very high levels. Whether numbers exceed or miss estimates could impact markets trying to forecast the Bank of England’s next move.
Wednesday: Federal Reserve Open Market Committee (FOMC) minutes of the July meeting
Our thoughts: the market is going to be starved of Fed meetings and communication during the summer recess (from 26 July to 21 September) and hence may have to fly on auto-pilot regarding monetary policy. True, there is a symposium at the end of August in Jackson Hole, Wyoming, where central bankers meet and from where some opinions or statements normally emerge, but they tend to define longer-term policy changes rather than short-term rate moves. The market is therefore likely to latch on to the minutes from the July meeting for clues as to where the September decisions could go.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed speakers reiterate rate views despite lower inflation print. Also, was the Chinese rate reduction an emergency cut?
Fed members repeated the message of rising interest rates despite a softer inflation number. Minneapolis Fed President Neel Kashkari said he wants the Fed’s benchmark interest rate at 3.9% by the end of this year and at 4.4% by the end of 2023, adding that he has not seen anything that changes the expected path of rates.
Charles Evans, Chicago Fed President, said he expects the target range to rise to 3.25%-to-3.5% by the end of 2022 and to 3.75%-to-4% by the end of 2023: “I expect that we will be increasing rates the rest of this year and into next year to make sure inflation gets back to our 2% objective.”
San Francisco Fed President Mary Daly said it was too early to declare victory and did not rule out another 75 bp hike in September (although she currently prefers 50 bps) and also pushed back on expectations of rate cuts in 2023.
Richmond Fed President Thomas Barkin said: “There’s more to come to get rates into restrictive territory.” He also said he would like to see PCE inflation (Personal Consumption Expenditures, the Fed’s inflation gauge) running at target for some time.
During the week, President Biden signed the US CHIPS and Science Act, which provides US$280bn in new funding to boost domestic research and manufacturing of semiconductors in the US. The Inflation Reduction Act, which provides for US$370bn of investment in a low-carbon economy, paid for by prescription drug savings and corporation tax increases, was approved by Congress for his signature.
The Chinese one-year medium-term lending facility rate was cut from 2.85% to 2.75% in what was seemingly a reaction to poor economic data.
Market paying attention to lower CPI/PPI prints but not to dreadful productivity loss clawing back post-COVID-19 gains
Inflation: in the latest survey by the New York Fed, expectations for US inflation three years ahead fell to 3.2% in July, from 3.6% the previous month, with the outlook for inflation in the coming year down to 6.2% from 6.8%. The University of Michigan sentiment survey inflation expectation similarly fell from 5.2% to 5.0% for one-year inflation but increased from 2.9% to 3.0% for 5-10-year inflation.
The small business owners survey found that 56% of them are raising prices, while 37% are planning to do so. Both are down from their peaks earlier this year but remain in record-high territory.
The CPI was flat in July, slowing to 8.5% year-on-year. The core CPI (ex food & energy) rose 0.3%, keeping the year-on-year number at 5.9%. Both core and headline CPI surprised to the downside in July. Breaking down the CPI print, services (ex food and energy) were 3.2% of the 8.5%, still rising; energy fell to 2.4% (down from 3.0%); goods ex food and energy were down to 1.4% (from 1.5%); but food was still rising, up to 1.5% (from 1.4%). The whole drop therefore comes from energy.
The PPI surprised by falling for the first time in more than two years, here too largely reflecting a drop in energy costs. The final demand PPI decreased 1.5% on the month and was up 9.8% year-on-year. The pullback was due to a decline in the costs of goods, whereas services prices edged up. Excluding food and energy, the core PPI rose 0.2% from June and 7.6% year-on-year. Some 80% of the decline in goods prices was due to a 16.7% plunge in petrol prices.
Import prices fell 1.4% in July for a year-on-year increase of 8.8%, down from 10.7% the previous month. Import prices ex petroleum fell 0.7% on the month. Export prices fell 3.3% in July for a year-on-year increase of 13.1%, down from 18.1%.
Productivity: productivity fell 4.6% annualised in Q2, on top of the revised 7.4% plunge in Q1, the weakest two-quarter performance since records began in 1947, at -2.5% year-on-year. Given that productivity soared after lockdowns in 2020 by 10.3% during Q2 and 6.2% during Q3, the current data bring productivity back to where it was during the first half of 2020. Unit labour costs, on the other hand, rose 10.8% in Q2 following a 12.7% surge in Q1.
Employment: initial jobless claims increased to 262K this week from 248K, now in a clear upward trend from the 166K bottom in March. Continuing claims also rose from 1420K to 1428K, a slow grind up as well.
Surveys: the University of Michigan sentiment index surprisingly rose from 51.5 to 55.1, with current conditions falling from 58.1 to 55.55 but expectations surging from 47.3 to 54.9.
Economic growth dropped in June resulting in a negative Q2 print. House prices starting to move down
Retail: the BRC (British Retail Consortium) sales like-for-like rose 1.6% year-on-year in July, up from a negative -1.3% in June.
Housing: the RICS (Royal Institute of Chartered Surveyors) housing market survey showed sales expectations for the next 12 months at the lowest level since March 2020. The RICS house price balance fell from 65% to 63%, combining lack of supply and weak demand. The Rightmove house price index dropped 1.3% in August for a year-on-year 8.2% growth, down from 9.3%.
Growth: the June GDP was down 0.6%, driven by construction output falling 1.4% (well anticipated by the construction PMI drop), manufacturing production dropping 1.6% and also services down 0.5%. Q2 GDP eased 0.1% overall, with government spending falling the most but total business investment surging and the consumer (namely private consumption) in between, down 0.2%.
Trade: the UK trade deficit hit a record of £27.9bn during Q2, with energy costs mostly to blame for the increase.
Better than expected
Surveys: in the eurozone, the Sentix investor confidence was marginally higher at -25.2 from -26.4.
Industry: industrial production in the eurozone rose 0.7% in June for a year-on-year growth of 2.4%, both markedly above estimates.
China’s inflation is not a problem, but growth might be
China: the CPI was below estimates at 2.7% with core CPI at 0.8%. The PPI came in at 4.2%. Chinese supply chains seem to be easing, with delivery times in global electronics and autos improving and price indicators also showing broad cooling.
The July data release showed industrial production at 3.8% year-on-year, down from 3.9%; retail sales at 2.7% from 3.1%; fixed assets ex rural (i.e. property) at 5.7% from 6.1%; property investment at -6.4% from -5.4%; new home prices down 0.11% on the month and the surveyed jobless rate improving to 5.4% from 5.5%.
Japan: machine tool orders were softer in July, up 5.5% year-on-year, down from 17.1% previously, in a sign that global manufacturing is softening. Q2 GDP growth was 0.5% annualised to 2.2%, with private consumption up 1.1%; business spending up 1.4%; inventory contribution as a percentage of GDP at -0.4% and the net exports contribution flat. The Q2 deflator was negative at -0.4%.
In June, capacity utilisation surged 9.6% after a heavily negative month and industrial production was upgraded to 9.2%.
Record US oil output but increased energy consumption keep market more balanced
US crude oil output reached 12.2 million bbls/day, the highest level since March 2020.
The International Energy Agency (IEA) boosted its forecast for global oil demand growth this year as soaring natural gas prices and heatwaves spur industry and power generators to switch their fuel to oil. According to the IEA, world oil consumption will now increase by 2.1 million bbls/day this year, or about 2%, up 380,000 a day from the previous forecast.
Norway decided to halt its natural gas exports, which is going to affect the UK more than any other country as Norway is responsible for about 60% of the UK’s total gas demand.
Over the week, Brent oil rose 3.5%, copper 2.8% and gold 1.5%.