Markets last week

Another see-sawing week for markets, with depths of despair followed by strong rallies. Concerns centred round inflation risks, profitless technology companies, central bank policy uncertainty and China’s zero-COVID-19 lockdowns. On the other hand, US Federal Reserve (Fed) Chair Powell’s speech on Thursday reassured investors. He reaffirmed that the Fed is likely to hike by 0.5% at each of its next two meetings and restated that the Fed wasn’t “actively considering” 75 bps. The Fed may be expecting consumers to slow down their purchasing in line with the falling University of Michigan sentiment survey, although the strong dollar is also helping keep a lid on imported inflation in the US.

The COVID-19 situation in mainland China remains unchanged with close to 40% of the population under some form of lockdown seriously impacting the Chinese economy. There are expectations of a forceful policy response from the Chinese authorities, which acted as a tailwind to sentiment in Far Eastern markets at the end of the week. Meanwhile, the monthly data from China was more negative than at any time since early COVID-19 days.

One important development was the turnaround in government bond yields. After hitting peaks in yields 10 days ago, we saw a massive drop in US treasury and UK gilt yields during last week, as government bonds started to react to the possibility of a recession, not just to future monetary policy tightening. As a result, bonds lost their recent correlation to equities and went in their more traditional opposite direction.

The end of the quarterly earnings reporting season is upon us. Although companies have beaten earnings estimates meaningfully, by 5% in the US and 10% in Europe, the ongoing guidance given by these firms has been much less buoyant and has contributed to the market correction. Unsurprisingly, the energy sector has shown the strongest profit acceleration, together with materials and industrials. In a sign of the times, as the energy sector rises and information technology falls, it’s interesting to note that Saudi oil giant Aramco has overtaken Apple as the world’s largest company by market capitalisation.

Looking at equities over the past 6-12 months, some companies have given up most of their post-COVID-19 gains and some indices, in particular small capitalisation indices, have lost half of their COVID-19 gains as well.

There was a sharp recovery in risk markets on Friday, which left shares mixed for the week. By the end of the week, government bond yields fell sharply, by 20-25 bps for 10-year maturities. The US dollar was still dominant, although the Japanese yen was the strongest developed currency. Oil prices recovered mid-week to finish flat. There was only one positive equity sector, consumer staples, whilst the worst sectors were technology and materials. Europe ended up as the strongest region and emerging markets the weakest.

The week ahead

Wednesday: UK CPI, RPI and PPI

Our thoughts: the Bank of England scared everybody with gloomy economic forecasts. Growth is likely to fall sharply due to soaring inflation acting as a consumer tax, on top of increased national insurance contributions, a challenging trade situation with Europe and a weak currency feeding into imported inflation. This grim equation is almost entirely determined by the path of future inflation. The CPI (consumer price index) is the visible inflationary cost, with Governor Bailey even forecasting a double-digit reading at some point this year. How close are we going to be this month? Also, the PPI (producer price index) input and output will have an impact on future price rises and bear monitoring. Will PPI input reach 20%? German input inflation currently exceeds 30%, so a spurt in the UK is possible, too. How will markets react to the inflation numbers? Have they been sufficiently discounted by investors, or do they still have the power to rattle markets?

Wednesday: US housing starts and building permits

Our thoughts: the huge increase in mortgage rates this year (roughly from 3% to 5.25%), coupled with the strong rise in house prices over the last two years may have made property purchases unaffordable for many Americans. As we know, their propensity to consume depends on how rich they feel, and property values make up a large part of that sentiment. Existing home sales are suffering as a result, but the biggest issue in the US property market now is not house prices or mortgage rates but supply, or rather unavailability of supply. As a result, many Americans are choosing to build instead. Housing starts and building permits have continued on their upward trend even as existing home sales have fallen. The question is whether this equation will continue for long as the Fed tightens money policy.

Thursday: Japan national CPI

Our thoughts: Japan has had flat to negative inflation over the last two decades at least, so the current price pressures are likely to have an impact on consumer spending as well as export pricing. The headline CPI (consumer price index) is expected to double from the current 1.2% and the CPI ex fresh food and energy, which is the Bank of Japan’s gauge with a target of 2%, is finally anticipated to move into positive territory. The Bank of Japan is still the most dovish central bank in the developed world, perhaps in the whole world. Will they budge if the inflation numbers suddenly surge?

The numbers for the week 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

The Fed confirms 50 bp hikes ahead and the ECB signals rate rises

In the eurozone, with inflation approaching four times the 2% target, European Central Bank (ECB) officials are now flagging rate hikes in July for the first time since 2011, right after they stop asset purchases (quantitative easing). ECB President Christine Lagarde stressed that subsequent rate moves won’t be aggressive. “After the first rate hike, the normalisation process will be gradual”. Markets are now forecasting a positive ECB rate by year-end (currently -0.50%).

US Federal Reserve (Fed) Chair Jerome Powell reaffirmed that the Fed is likely to hike by 0.5% at each of its next two meetings, whilst leaving open the possibility it could do more. Powell made clear his determination to get inflation under control but conceded that the Fed’s ability to do that without triggering a recession may depend on factors outside its control. “If the economy performs about as expected, it would be appropriate for there to be additional 50-basis point increases at the next two meetings.” He restated that the Fed wasn’t “actively considering” a 75 bp hike.

The People’s Bank of China (PboC) kept its one-year medium-term lending facility rate at 2.85%.

United States

Mixed signals: strong employment, resilient housing, but slumping consumer confidence and confusion over the direction of inflation

Sales: wholesale trade sales rose 1.7% in March, up from 1.5% the prior month.

Surveys: the NFIB small business optimism index remained at 93.2. The bellwether University of Michigan consumer sentiment index slumped from 65.2 to 59.1 with current conditions falling from 69.4 to 63.6 and expectations from 62.5 to 56.3.

Housing: MBA mortgage applications had a second positive week, up 2.0%, after 2.5%.

Inflation: the US CPI (consumer price index) rose 0.3% and 8.3% year-on-year, which reflects some moderation, but the core CPI surged 0.6% and 6.2% year-on-year. Durable goods inflation has fallen, but inflation is broadening into services (dining out and transport). Housing inflation is climbing, with the owners’ equivalent rent approaching 30-year highs. It means that sticky inflation, as calculated by the Atlanta Fed, is still rising, while flexible inflation is falling.

The PPI (producer price index) rose 0.5% in April, after 1.4% the prior month, trimming the year-on-year increases from 11.5% to 11.0%. Likewise, the PPI ex food and energy rose 0.4%, vs. 1.2% previously for an 8.8% year-on-year growth, down from 9.2%.

Import prices rose 0.4% in April for a year-on-year growth of 12% vs. 13% the previous month and export prices rose 0.6% for a year-on-year of 18.0% down from 18.6%.

The embedded inflation expectations within the University of Michigan sentiment survey were unchanged at 5.4% for 1-year inflation and 3.0% for 5-10-year inflation.

Employment: initial jobless claims were almost unchanged at 203K vs. 202k for the week, whereas continuing claims kept falling, now at 1343K vs. 1387K.

United Kingdom

The economic slowdown is starting to be felt in the data

Sales: the BRC (British Retail Consortium) like-for-like sales for April fell to -1.7% year-on-year from -0.4% the previous month.

Growth: GDP rose 0.8% in Q1 or 8.7% year-on-year with government spending heavily negative but investment very strong. In March, the economy fell 0.1%, down from +0.1% in February. The details shows that industrial production and services were both down 0.2%, whereas construction output was up 1.7%, above expectations.

Trade: the visible trade balance was worse in March at £23.8bn vs. £21.6bn the prior month.

Housing: the RICS house price balance rose from 74% to 80%.

Europe

Poor economic numbers overall

Surveys: the Sentix eurozone investor confidence fell further from -18.0 to -22.6. The bellwether ZEW survey was a little better, with the eurozone survey showing expectations up from -43.0 to -29.5, whilst the expectations for Germany were up from -41.0 to -34.3 with the current situation worse at -36.5 vs. -30.8.

Industry: industrial production in the eurozone fell 1.8% in March for a year-on-year drop of 0.8%. Previous monthly numbers were positive.

China/India/Japan/Asia

Chinese data pointing to recessionary conditions

China: the CPI (consumer price index) increased from 1.5% to 2.1% in April, but the PPI (producer price index) fell from 8.3% to 8.0%, albeit above estimates. FDI (foreign direct investment) into China in April is up 20.5% year-on-year in Renminbi, not in US dollars, down from 25.6% the prior month.

Money supply in April was strong and rose from the previous month: M0 at 11.4% year-on-year, M1 at 5.1% and M2 at 10.5%.

The April data release was extremely negative, with industrial production down from +5.0% year-on-year to -2.9%, retail sales from-3.5% to -11.1%, fixed assets ex rural (i.e. investment) from +9.3% to +6.8%, property investment from +0.7% to -2.7%, residential property sales from -25.6% to -32.2% and the surveyed jobless rate rising from 5.8% to 6.1%.

Japan: household spending in March was down 2.3% year-on-year from +1.1% the prior month. The leading index CI improved from 100.1 to 101.0 with the coincident index up a smidge from 96.8 to 97.0. The Eco Watchers Survey was also better, with the current situation rising strongly from 47.8 to 50.4 and the outlook up marginally from 50.1 to 50.3.

Machine tool orders growth in April eased to 25% vs. 30% the prior month.

Oil/Commodities/Emerging Markets

Oil prices don’t want to go down

Oil rallied after slumping for two days, extending gains after US fuel inventories plunged ahead of the summer driving season and COVID-19 infections in Shanghai and Beijing dropped on Tuesday. Brent crude reclaimed the US$110 handle on Friday.

Copper fell briefly through US$9,000/tonne and finished the week at US$9,159.

Gold fell to the low US$1,800’s, ending the week at US$1,811, although non-US holders have been cushioned by the dollar strength