Markets last week
Once again, markets reacted to inflation data last week. The US Consumer Price Index (CPI) fell in line with expectations to 6.5% for the headline and 5.7% for the core reading. Bond and equity markets alike were positive on the numbers under the assumption that the fall in inflation readings would lead to the US Federal Reserve (Fed) to amend its tightening policy. Although no Fed official has spoken of cutting interest rates this year, many of them have started voicing the view that the upcoming hikes should be less, with 25 bps seeming to emerge as a consensus in the market. It has to be said that not all Fed officials have stated the same benign opinion, which foreshadows a period of uncertainty on Fed rates in the next two to three weeks before the next meeting.
The CPI print and the Fed official comments added the final spark to a strong equity market over the week as well as a fall in government bond yields.
The Chinese economic reopening seems to be old news by now, but there are indications that at the end of 2022, 40% of the Chinese population may have been infected with COVID-19. The Chinese government announced that 60,000 people have died of the virus over the last month. This is obviously putting pressure on the healthcare system, but also on the economy in general, with sick leave and diminished mobility ahead of the Chinese New Year at the end of this week. The Chinese markets have nevertheless been among the strongest this year to date, due to the increased activity and loosening of regulations.
The risk-on environment has driven the US dollar down vs. all other currencies: one notable example is the USD vs. Japanese yen falling below 127 yen per dollar, which is also influenced by the recent change in Bank of Japan policy regarding yield curve control. The greenback is now overall more than 10% down on its peak in September. In line with the weaker US dollar, commodities have resumed their strengthening, with oil prices up over 8% but also industrial metals surging (copper up 7%). Lastly, gold prices have recaptured the US$1,900 handle with strong upward momentum, as markets assume that the People’s Bank of China is the current major buyer.
Government bond yields have also been pushed down by the more positive view on inflation, dropping 5 bps for US treasuries and 11 bps for gilts.
The equity rally has been differentiated, however. Europe, Japan, Asia and emerging markets (which have cheaper valuations) have been leading and the more expensive US market has lagged. An interesting fact is that the Asia-Pacific equity index is now officially in a bull market, up more than 20% from its bottom on 24 October. The best sectors last week were the technology complex, materials and real estate and the worst were defensive areas like healthcare and consumer staples.
The week ahead
Tuesday – Wednesday: Bank of Japan meeting
Our thoughts: it isn’t very often that markets bother to listen to the Bank of Japan (BoJ) but this time around, they might. With the BoJ changing its policy on yield guidance for Japanese Government Bonds (JGBs) and Governor Haruhiko Kuroda’s retiring on 8 April, there is the possibility of a slight change of tone which could have an impact not just on the JGB market and Japanese yen but also on other bond markets, since Japanese buyers are among the largest buyers globally.
Wednesday: UK CPI
Our thoughts: will UK inflation come down and, if so, by how much? The current CPI double-digit number is still so far above the Bank of England’s 2% target that any prospect of a change in the current tightening policy is at the very least premature. In the context of markets trying to find good news on inflation to feed their current bullish instincts, British inflation might be on the radar, too, and any surprise one way or another might move markets.
Wednesday: US PPI
Our thoughts: markets definitely want more information on inflation in the US. The Producer Price Index (PPI) might seem more obscure than its CPI cousin, but it can give good insights on pipeline price rises, particularly given the detailed readings of ‘final demand’, ‘ex food and energy’ and ‘ex food, energy and trade’. Once again, the question will be whether the recent falls in inflation are caused by a small number of items, such as energy and commodities, or whether the falls are more broad-based, which would be reflected in the ex food and energy category.
The numbers for the week
Central banks/fiscal policy
A flurry of Fed speakers starting to show some divergence in views. Bank of England official still concerned about inflation.
Many officials from the US Federal Reserve (Fed) expressed their opinions, showing less of a consensus among them.
Raphael Bostic, President of the Atlanta Fed, said “we are just going to have to hold our resolve” and went on to say the Fed was committed to tackling high inflation, which requires raising interest rates to a 5% to 5.25% range. After the release of the CPI on Thursday, Bostic said that “this report was really welcome news… it really suggests that inflation is moderating … if the information we get from business leaders and others is consistent with that… I’ll be comfortable moving at a slower rate, even 25 basis points”.
San Francisco Fed President Mary Daly said she expects the Fed to raise interest rates to somewhere above 5%, though the ultimate level is unclear and will depend on incoming data on inflation. Daly said holding the federal funds rate at its peak for 11 months is a “reasonable starting point”.
Philadelphia Fed President Patrick Harker said the Fed should lift interest rates in ¼% increments from now on. “I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed. In my view, hikes of 25 basis points will be appropriate going forward.”
The message of moderation was later reinforced by Richmond Fed President Thomas Barkin, who said that “it makes sense to steer more deliberately as we work to bring inflation down”. St. Louis Fed President James Bullard, however, said that he continued to favour front-loading policy moves to get rates above 5% “as soon as possible”.
Bank of England (BoE) Monetary Policy Committee (MPC) member Catherine Mann, one of the most hawkish members of the MPC, said underlying inflationary forces in the UK look “pretty robust,” a signal she’s still pushing for big interest-rate increases despite the prospect of recession. “That’s what we’re worrying about the underlying inflation dynamic, which is something that is my responsibility to address. That underlying inflation dynamic looks pretty robust right now. And our job is to bring that to 2%.”
Mann said households when polled are anticipating inflation of 4% or more, an expectation that the central bank needs to ensure doesn’t stick. That may require a “significant recession. Getting inflation expectations under control, keeping them under control, is important… Nobody likes to have higher interest rates, but nobody likes to have double digit inflation either”. Expressing a concern about people below retirement age who are no longer working. “If you’re retired, and you have a portfolio and a pension, that’s fine. But for somebody who’s not in the labour force at age 50, there’s going to be 30 more years to go. Who is going to finance that? That is a really important intergenerational question.”
A survey by the European Central Bank (ECB) showed that consumer expectations for inflation over the next 12 months eased for the first time since May 2022. The poll was conducted in November, when eurozone inflation slowed for the first time in 1 1/2 years. Expectations for the next 12 months declined to 5% from 5.4% in October, with 3-year expectations down to 2.9% from 3% and expectations for economic growth for the next 12 months better, at -2% vs. -2.6%.
The CPI number that moved markets was probably over-interpreted. The employment market is as tight as ever and surveys are mixed
Inflation: the widely followed CPI announcement created waves in the markets. On the face of it, inflation came down from 7.1% to 6.5%, with the core CPI down from 6.0% to 5.7%. The details, however, show that the drop came from energy and other goods, whereas services inflation actually rose during the month and is now responsible for 4.1% of the 6.5% headline CPI. Real average hourly earnings improved marginally from -2.1% year-on-year to -1.7%.
Inflation expectations embedded within the University of Michigan sentiment survey fell sharply for the 1-year reading, from 4.4% to 4.0% but edged up from 2.9% to 3.0% for the 5-10-year number.
The import price index rose 0.4% in December, up from -0.7% previously, for a 3.5% year-on-year growth, with the import price index ex petroleum up from -0.3% to +0.8%. The export price index fell 2.6% during the month, after -0.4% the prior month, for a 5.0% year-on-year increase.
Employment: the weekly jobless claims data continued to show a strong jobs market. Initial claims stayed almost unchanged at 205K whilst continuing claims fell from 1697K to 1634K.
Surveys: the NFIB (National Federation of Independent Business) small business optimism index fell from 91.9 to 89.8, the lowest level since the height of the pandemic and a large drop from the peak of 108.8 in 2018. On the other hand, the University of Michigan sentiment index rallied quite strongly from 59.7 to 64.6, with current conditions up from 59.4 to 68.6 and expectations up from 59.9 to 62.0.
Housing: MBA mortgage applications rose 1.2%, after the previous week’s drop of 10.3%.
The UK may be skirting a recession according to the most recent number, but job ads point to weakness ahead
Growth: November showed a small increase in GDP of 0.1% with the 3-month growth number rising from -0.4% to -0.3%. Services provided the uplift, up 0.2%, whilst manufacturing production was down 0.5%, construction output was flat and the trade deficit ballooned.
Retail: the BRC (British Retail Consortium) like-for-like sales improved to 6.5% year-on-year in December from 4.1% previously.
Employment: UK online job advertisements fell below pre-COVID levels with a 16% drop in total jobs advertised in the first week in January compared to the previous year.
Conflicting data point to a lack of economic direction
Surveys: the Sentix investor confidence survey for the eurozone improved from -21.0 to -17.5.
Employment: the eurozone unemployment rate for November remained at 6.5%.
Industry: French industrial production recovered from -2.7% year-on-year to +0.7% in November with manufacturing leading the gains. Eurozone industrial production, however, fell to 2.0% in November from 3.4%.
Slight increase in inflation with higher imports in China
China: money supply was fairly stable, with M0 up 15.3% year-on-year vs. 14.1% previously, M1 down from 4.6% to 3.7% and M2 down from 12.4% to 11.8%.
The CPI rose from 1.6% to 1.8% and the PPI increased from -1.3% to -0.7%, showing that China is not exporting inflation.
Export growth fell further, with the year-on-year reading at -9.9% down from -8.9%, whereas imports rose from -10.6% to -7.5%. The trade surplus increased from US$69.2 bn to US$78 bn.
Japan: the Leading Index CI fell from 98.6 to 97.6, whilst the Coincident Index eased from 99.6 to 99.1. The Eco Watchers Surveys were mixed, with the current reading down from 48.1 to 47.9 but the outlook rising from 45.1 to 47.0.
Household spending in November remained at a depressed -1.2% year-on-year. The money stock decreased somewhat, from 3.1% year-on-year to 2.9% for M2 and from 2.7% to 2.5% for M3.
Weaker US dollar driving commodities higher
The relentless rise of gold continued over the last week with the US$1,900 threshold firmly broken on rumours that the Chinese central bank might be behind most of the buying.
There was a strong recovery in industrial metals on the back of the Chinese economic reopening, with copper surging almost 7%.
Oil prices were even firmer, soaring more than 8% for the US and international gauges.