Markets last week
There was a complete reversal in mood and direction from the previous week, with the biggest weekly rally in equities since March, during the recovery from the Silicon Valley Bank failure.
Markets were given a strong dose of optimism on Wednesday by the publication of a US inflation print below estimates. This time around, it wasn’t just the headline Consumer Price Index (CPI) that fell below expectations to 3.0%, but also the core CPI (ex food and energy) down from 5.3% to 4.8%. Optimism on price stability was reinforced by a very weak US Producer Price Index (PPI) on Thursday.
The core inflation reading, however, is still more than twice the target for the US Federal Reserve (Fed). The Fed ‘s next meeting takes place at the end of the month and there is still a general assumption that they will hike rates by 25 bps in July. A further rate rise in September, however, is now being increasingly priced out by futures markets amid the lower inflation outlook.
The impact of that US CPI was felt in global bond markets, where yields fell an average of 20 bps and also in the expectations for Bank of England (BoE) rates, which were taken down approximately 0.3% by next March, still leaving the projected BoE rate above 6% by the end of the year.
Sterling rose to a 15-month high against the US dollar as wage growth accelerated in the UK. The US dollar fell sharply on the softer inflation print in the US and is now down 13% from its peak last September. The Japanese yen soared on the expectation of the Bank of Japan tweaking its yield curve control later this month.
A very timid extension of steps designed to support the Chinese property sector, amid generally lacklustre Chinese data, helped Asian shares on Tuesday but did not seem to have any legs. Q2 and June growth data over the weekend further confirmed the Chinese economic slowdown.
Equities enjoyed a strong week globally, but this year’s leaders, the US and Japan, lagged the rally. American shares did well, but only in dollar terms and lost most of it in the currency translation. Japan, on the other hand, enjoyed a sharp rise in the yen, but this affected the attractiveness of equities, which are normally inversely correlated to the Japanese yen.
The best stock markets were Europe and Asia ex-Japan. In terms of sectors, although the technology complex was still riding high, many other areas behaved equally well last week, such as materials, financials and industrials, as investors have been slowly taking profits on this year’s winners and moving to some of the laggards.
Oil prices surged early in the week with the Brent crude gauge rallying above US$80/bbl for the first time since April. This may have been a factor in energy’s stronger showing among equities, but Friday saw falls in both the oil price and energy shares mostly driven by fears of a further Chinese slowdown.
The week ahead
Monday-Thursday: Empire Manufacturing survey and Philadelphia Fed Business outlook
Our thoughts: there is a considerable degree of confusion as to the direction of the US economy, after it has performed much better than expected this year. The question is whether the cumulative effect of 5% in interest rate hikes will end up having an impact on economic activity. Surveys have been mixed recently but they are still the best forecast of future growth. The two that are normally paired as the bellwether for the economy are the Empire Manufacturing (NY State) and the Philadelphia Fed Business Outlook, generally good predictors of Purchasing Managers’ Indices (PMI) for the whole country.
Wednesday: UK inflation
Our thoughts: the UK has the unenviable pole position for highest inflation in the G7 group of countries and the rate seems to be even stickier than in other places. Headline inflation is dropping fast in the US and Europe (though core inflation is moving at a glacial pace). The UK CPI headline and core, will doubtless move many markets, given that British assets, whether equities or gilts, have been sold down by global investors, but sterling has benefited from the expectation of a hawkish BoE monetary policy. Any upside or downside surprises in CPI could affect these market moves. Investors will also be looking at the PPI for signs of pipeline inflation, which has been falling quite sharply elsewhere in the world.
Friday: UK public finances
Our thoughts: British news flow is cluttered with predictions of the next general election, and whether the current government has the ability to deliver pre-poll tax cuts. In that respect, the state of UK public finances will help determine whether that narrow path will be available. The Public Sector Net Borrowing (PSNB) is the crucial datapoint for that option, against the backdrop of the last four months showing very high deficits, revised upwards to boot. Will the public finances get a break in June, and will that impact sterling, gilts and other British assets?
The numbers for the week
Central banks/fiscal policy
Usual battle of words among officials of the Fed about future monetary policy ahead of the next meeting
BoE Governor Andrew Bailey said inflation is likely to drop “markedly” this year, but he expects the British economy to be affected by interest rate increases. “Some of that tightening is still to come through the policy pipeline, and we expect underlying inflationary pressures to recede as headline inflation falls… The interaction of above target headline inflation, with labour market tightness and demand pressure in the economy, has made underlying developments in goods and services price inflation more sticky (sic) than previously expected. Both price and wage increases, at current rates, are not consistent with the inflation target.”
Various speakers from the Fed outlined their views on interest rates and inflation. San Francisco Fed President Mary Daly suggested that the Fed was near “the last part” of its cycle, later during the week suggesting that the economy still had a lot of momentum, whereas Cleveland Fed President Loretta Mester mentioned the possibility of two more rate hikes from the Fed.
Atlanta Fed President Raphael Bostic thought that inflation could return to target without the need for further interest rate hikes. Richmond Fed President Thomas Barkin, however, wanted to continue with hikes: “Inflation is too high. If you back off too soon, inflation comes back strong, which then requires the Fed to do even more.”
Fed Governor Christopher Waller was even more forthright, expecting the Fed to have to raise rates twice more this year: “I see two more 25 basis point hikes in the target range over the four remaining meetings this year as necessary to keep inflation moving toward our target.”
The People’s Bank of China left the one-year medium-term lending facility rate unchanged at 2.65%.
Falling inflation is contradicted by higher inflation expectations amid stronger surveys
Housing: the 30-year mortgage rate rose to 7.07% in the week ending 7 July, as reported by the Mortgage Bankers Association (MBA). Concurrently, MBA mortgage applications rose 0.9%, up from -4.4% the previous week.
Inflation: the CPI fell more than expected. The headline reading dropped from 4.0% to 3.0%, the lowest level since October 2021, and the core CPI ex food and energy from 5.3% to 4.8%. Real (meaning net of inflation) average hourly earnings surged from +0.2% to +1.2% year-on-year with real average weekly earnings rising from -0.6% to +0.6%.
The PPI also fell below expectations. The PPI final demand fell from 0.9% to 0.1% year-on-year, the lowest since March 2020, with the PPI ex food and energy at 2.4% down from 2.6% and the PPI ex food, energy and trade at 2.6% from 2.8%.
The import price index for June fell -0.2% and also -0.3% ex petroleum, for a year-on-year -6.1% fall vs. -5.7% the prior month. The export price index fell -0.9% for a -12.0% year-on-year move.
The inflation expectations embedded within the University of Michigan survey increased for one-year inflation from 3.0% to 3.1% and from 3.3% to 3.4% for 5-10-year inflation.
Surveys: the National Federation of Independent Business (NFIB) small business optimism index picked up from 89.4 to 91.0, although it has been in a downturn since 2018 and the current recovery is very small in comparison.
The bellwether University of Michigan sentiment index soared from 64.4 to 72.6, the highest level since September 2021 with current conditions up from 69.0 to 77.5 and expectations from 61.5 to 69.4.
Consumer Credit: consumer credit fell from US$20.3bn to US$7.24bn in May.
Employment: jobless claims once again reversed trend, with initial claims falling from 249K to 237K but continuing claims rising from 1718K to 1729K.
Is British employment finally getting hit by slowing activity and higher mortgage rates?
Employment: a small increase in unemployment was registered, whether on the UK statistical network or the International Labour Organisation data (ILO). The claimant count rate for June rose from 3.9% to 4.0% with the jobless claims change increasing 25.7K (up from -22.5K) and the payrolled employees monthly change down -9K from +20K previously.
The May ILO data also showed unemployment rising from 3.8% to 4.0% with the employment change 3 months/3 months falling from 250K to 100K.
Housing: the 2-year fixed-rate mortgage rate rose to 6.66%, the highest since August 2008, with the 5-year loan rate at 6.17%. The Rightmove house price index in July fell 0.2% for a year-on-year growth of 0.5% vs. 1.1% previously.
Retail: the British Retail Consortium (BRC) sales like-for-like rose 4.2% in June year-on-year, up from 3.7% the prior month.
Inflation: average weekly earnings rose from 6.7% year-on-year to 6.9% over the last three months to May.
Growth: May GDP was negative -0.1%, albeit better than consensus, driven by manufacturing production falling 0.2% and construction output also down 0.2%. The trade deficit surged but the index of services was flat for the month. Over the last three months growth was flat. The May number may have been affected by the extra coronation bank holiday.
Surveys continuing to worsen
Surveys: the Zentrum für Europäische Wirtschaftsforschung (ZEW) eurozone expectations survey fell from -10.0 to -12.2 with the Germany only survey also falling from -8.5 to -14.7 and the current situation worsening from -56.5 to -59.5.
The Sentix investor confidence survey for the eurozone dropped from -17.0 to -22.5.
Industry: eurozone industrial production rose 0.2% in May, down from 1.0% the previous month.
Inflation: the German wholesale price index fell further in June, -0.2% for a year-on-year drop of 2.9%.
Chinese data disappointing again
China: money supply growth was slightly lower, with M2 down from 11.6% to 11.3%, M1 down from 4.7% to 3.1% but M0 up from 9.6% to 9.8%. June trade data disappointed, with both exports and imports falling sharply. Exports were down 12.4% year-on-year (in US dollars), worse than the previous -7.5%, and imports fell 6.8%, below the prior -4.5%.
Second quarter economic growth was lower than expected, at 0.8%, compared to 2.2% for Q1. The year-on-year number is flattered by the comparison with last year’s lockdown situation, at 6.3%, but is below consensus estimates.
June economic releases were generally disappointing, with industrial production improving at 4.4% year-on-year vs. 3.5% the previous month but retail sales slumping from 12.7% to 3.1%, fixed assets ex rural (i.e. investment) easing from 4.0% to 3.8%, property investment continuing its slide to -7.9% from -7.2% and residential property sales down from 11.9% to 3.7%. The surveyed jobless rate was unchanged at 5.2%, but youth unemployment jumped to 21.3%.
Japan: machine tool orders for June were a smidge better at -21.7% year-on-year from -22.1% previously. Machine tools are an important gauge of global manufacturing activity. The more domestically orientated core machine orders fell 8.7% year-on-year, down from -5.9%. Capacity utilisation dropped 6.3% in May, after +3.0% the previous month.
The PPI fell from 5.1% to 4.1%, below estimates. The money stock numbers were unchanged, with the M2 money stock up 2.6% year-on-year and the M3 money stock up 2.1%.
Fall in dollar helps commodities
The Brent crude oil gauge exceeded US$80/bbl for the first time since May but corrected on Friday and oil prices finished up only 2% for the week.
Crude oil inventories rose by 5.95 million barrels, as per the International Energy Agency (IEA). The IEA also downgraded oil demand outlook for the balance of 2023, due to a global slowdown, reducing expected world consumption by 220,000 barrels per day. This still leaves world fuel consumption rising 2.2 million per day in 2023.
Copper, industrial metals and other commodities were also boosted by the fall in the US dollar vs. most other currencies.