Markets last week
An inflation tantrum reared its ugly head in the US last week, sending both equities and bonds down sharply. The 4.2% headline year-on-year CPI (consumer price index) and 3.0% core CPI (ex food and energy) were above most estimates and stunned markets. The PPI (producer price index) and price change expectations from the University of Michigan confirmed the fears of higher inflation. Yet, looking at the detail of the CPI print, most of the scary numbers were likely to be one-offs, driven by the reopening of the economy and bottlenecks in supply chains, whereas the more essential components of a core price basket (rent, clothing, education and medical services) were quite stable. Investor sentiment recovered on Friday driving both equity and bond prices higher. It is unusual for government bonds to join in downward moves when equities fall, but it is indicative that concerns about inflation tend to hit bondholders as much as shareholders.
Corporate earnings strength has been exceptional this year, with earnings growth beating elevated expectations by more than 20% in both the US and Europe. Q1 earnings growth rose to 50% year-on-year for the US and 42% for Europe (including the UK). In addition, the proportion of companies beating earnings estimates is the highest in at least the last decade. Companies have not been rewarded for meeting or exceeding earnings estimates though, as beats were met with flat prices at best and results matching expectations caused sharp drops.
Japanese machine tool orders show how acute the bottlenecks can be, skyrocketing 120% year-on-year (vs. 65% previously). Economic data globally and confidence surveys continue to indicate strong positive feelings towards spending as countries reopen, but inflation numbers hijacked the markets discourse for a couple of days. Next month and the following are also slated to have eye-watering inflation numbers due to the comparison with last year and the difficulty of reopening economies after such long shutdowns. The US Federal Reserve’s (Fed) patience with ‘transient’ one-off inflation factors will therefore be tested. The reaction this week from Fed members was unworried and calming. Markets may need further reassurance though.
The roundtrip in equities during the week left markets down around 2%, with value sectors down 0.6% but growth sectors slumping 2.5%. The best markets were Europe and the UK and the worst Asia. Government bond yields ended up higher, particularly in the UK and the eurozone, with German yields racing to become positive after more than a decade of negative yields. Sterling was strong both vs. the US dollar and the euro. Commodities corrected but gold was resilient.
The week ahead
Wednesday: UK CPI (consumer price index), RPI (retail price index) and PPI (producer price index
Our thoughts: the US inflation scare is quite likely to repeat itself in the UK, where the reopening, as partial as it was, was met with storming retail sales. We start from a lower level, though, 0.7% for the CPI, which is expected to surge to 1.5%. The RPI is also estimated to soar from 1.5% to 2.4%, which should cause some issues for rental contracts in the current difficult environment. The PPI input is expected to jump to 8.5% and the PPI output to 3.4%. High PPI numbers may startle markets, as they are likely to influence future CPI levels, although as seen in China, they don’t correlate well. Just as in the US though, the devil will be in the details. Reopening plays may well feed into much higher prices, but the question is whether the stable part of a household budget (rent, clothing, food) will move at the same speed as transport and hospitality. Maybe the more progressive reopening of the UK economy compared to the US will spare us eye-watering inflation numbers?
Thursday: Philadelphia Fed Business Outlook Survey
Our thoughts: after the disappointing University of Michigan sentiment index, other sentiment surveys will be scrutinised closely and none more than the famous ‘Philly Fed’. It is currently expected to fall from 50 to the low 40s, although historically 40 has always been the peak of sentiment and hence the drop would not be characteristic of a change in sentiment, only a moderation of the froth. It tends to be paired with the Empire State survey (NY State), which is awaited on Monday and should show a flat trend.
Friday: UK manufacturing and services PMI, plus retail sales
Our thoughts: once again, in this period of recovery, economic numbers are volatile and hence surveys tend to give a better impression of what is really happening in the economy. April was a major reopening month in England and hence the services PMI should see a bounce: at this time, it is expected to be near a record level of 62.2 with manufacturing peaking just below that. Retail sales for April are expected to have another strong showing, like March, and the year-on-year growth could look ridiculous due to the base effect. A more relevant comparison would be a two-year growth rate. Markets should definitely react to the combination of data on Friday.
The numbers for the week
|In local currency||In sterling|
|Index||Last week||YTD||Last week|
|Hong Kong equities||-2.0%||2.9%||-2.8%|
|Emerging market equities||-3.0%||1.3%||-3.8%|
|Government bond yields (yield change in basis points)|
|Current level||Last week||YTD|
|10-year US Treasury||1.63%||5||72|
|10-year German Bund||-0.13%||9||44|
|Current level||Last week||YTD|
|Commodities (in USD)|
|Current level||Last week||YTD|
|Brent oil (bbl)||68.71||0.6%||32.6%|
|WTI oil (bbl)||65.37||0.7%||34.7%|
|Copper (metric tonne)||10240.5||-1.7%||31.9%|
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Comments from Fed members on inflation
Fed Vice Chair Richard Clarida said he was surprised by the jump in the CPI, but he thought it should prove largely transitory. Cleveland Fed President Loretta Mester agreed and added, “I think we’re in a good place right now with our policy and we’re going to adjust it as appropriate depending on how the actual recovery progresses. My baseline scenario for inflation is we’re going to have higher inflation this year, above 2%, but then as some of those constraints on supply ease I think we’re going to see inflation go back down and we’ll have to monitor that as we go forward.” She highlighted the fact that “opening up the economy after such a deep shock downward” would create some “stumbles”.
The inflation story dominates everything, but the devil is in the details
Surveys: the April NFIB index of small business activity and sentiment rose to 99.8 from 98.2, below estimates and still below the 104.0 October level. It looks like the NFIB membership was heavily pro-Trump and has been negative since the election. The University of Michigan Sentiment Index disappointed as well, falling from 88.3 to 82.8, with current conditions dropping from 97.2 to 90.8 and expectations from 82.7 to 77.6.
Housing: the median price for a single-family home in the US rose the most on record in Q1, according to the National Association of Realtors. Prices jumped 16.2% year-on-year to a record high of US$319,200.
Inflation: the April CPI (consumer price index) jumped 0.8% with the core gauge ex food and energy up by 0.9%, the biggest increase since April 1982. The year-on-year readings were 4.2% for headline CPI and 3.0% for core CPI.
Close to 60% of the monthly increase came from five reopening sectors: used cars, rental cars, lodging, airfares, and food away from home. Airline fares jumped 10.2%, used car and trucks rose 10%, hotels and motels 8.8%. The pandemic increased the demand for cars as people decided driving would be safer than public transport.
Other components were benign in price terms. Rents in the CPI rose 0.20%, after a 0.21% increase in March. For shelter prices to go up significantly, the labour market needs to heal. Clothing, education, and medical prices rose modestly in April. Excluding the reopening categories, the CPI increase in April was in line with the average since June last year. Indeed, core CPI is now back to its 2018-2019 trend.
The headline PPI (producer price index) rose 0.6% in April, with core PPI up 0.7%. The PPI was driven higher by components like steel scrap (up 18.4%) and airline fares (up 6.9%). As in the CPI, hotel room rates and car rental rates climbed fast. PPI goods prices are very sensitive to oil prices, which in April were 273% higher than a year ago.
The PPI rose to 6.2% year-on-year, but the comparison is with a -1.5% reading one year ago, which was the low for more than 10 years. Likewise, the core ex food and energy level of 4.1% is compared to a 0.3% number one year ago, the lowest since 2015.
The import price index rose 10.5% year-on-year in April and the export price index rose 14.4%, both underscoring the input cost pressures in the US economy.
The University of Michigan sentiment index 1-year inflation expectation surged to 4.6% from 3.4% the previous month and the 5-10-year inflation expectations rose to 3.1% from 2.7%.
Employment: initial jobless claims fell to 473K from 507K, confirming the previous week’s fall as a downward trend. The reopening allows firms to hold on to staff who would otherwise have been laid off, since firms are having trouble hiring.
Sales: retail sales were flat in April, a disappointment, after +10.7% in March. Ex autos sales fell 0.8% and the retail sales control group was down 1.5% on the month.
Industry: industrial production rose 0.7% in April following a storming 2.4% the previous month, with capacity utilisation increasing from 74.4% to 74.9%.
Soaring sales and house prices but in March construction was strongest
Sales: the BRC retail sales monitor showed year-on-year growth in sales increasing to 51.1% in April, from 13.9% in March, although the timing of Easter flatters the comparison. The more relevant 2019-2021 growth rate was 7.3% in April vs. 8.3% in March.
Housing: UK house prices rose at their fastest pace in seven months in April. Halifax shows that values climbed 1.4% vs. 1.1% in March, the highest rise since September. Prices are now 8.2% higher than a year earlier at a record £258,204. That’s the largest annual gain for 5 years. There’s still some influence of the stamp duty holiday in these numbers. The residential survey showed that the net balance of surveyors reporting rising house prices over the last 3 months increased to +75 in April, from +62 in March.
Economic growth: GDP rose by 2.1% in March, above estimates. In addition, February was revised up to 0.7%, from 0.4%. Manufacturing production rose 2.8% in March, construction output 5.8% and the index of services was up 1.9%. Within services, the education sector stormed ahead 8.6% with schools reopening and the distribution sector increased 2.9%.
The trade balance declined to -£2bn in March, from -£0.9bn.
Surging sentiment indices
Surveys: the headline Sentix investor sentiment index in the eurozone rose to 21.0 in May, from 13.1 in April. Both the current situation index, at +6.3 and -6.5 in April and the expectations, to 36.8 from 34.8, have risen.
The ZEW investor expectations index in Germany jumped to 84.4 in May from 70.7 in April.
Industry: industrial production, ex-construction, in the eurozone edged higher by 0.1% in March, but the year-on-year growth was 10.9% up from -1.8% the previous month.
Chinese PPI promises more supply chain price pressure ahead and Japanese machine tool orders highlight the extent of industrial bottlenecks
China: Chinese passenger vehicle sales were up 12.4% year-on-year. The PPI (producer price index) soared to 6.8% from 4.4%, a harbinger of more cost pressure on western economies (don’t forget Chinese PPI was negative one year ago). The CPI (consumer price index) however, rose only to 0.9% from 0.4%, showing that producer prices don’t feed all the way into consumer prices.
The monthly economic data show that Chinese growth acceleration has probably stalled. Industrial production increased 20.3% year-on-year in April vs. 24.5% the previous month, fixed assets ex rural (i.e. investment) rose 19.9% vs. 25.6%, property investment 21.6% vs. 25.6% and retail sales 29.6% vs. 33.9%. The surveyed jobless rate nudged down from 5.3% to 5.1%.
Japan: household spending was up +6.2% year-on-year in March vs. -6.0% the previous month. Machine tool orders soared further, up 120.8% year-on-year in April vs. 65.1% the previous month. The PPI (producer price index) surged from 1.2% to 3.6% year-on-year.
Cyclical commodities (copper, iron ore) suffered a correction last week. China was trying to put downward pressure on surging metals prices. The price curve for copper moved from backwardation (where forward prices are lower than current prices) to contango (where forward prices are higher than current prices), a move indicative of price softness as it tends to cause losses for holders of futures contracts. Oil prices recovered at the end of the week.
Gold was very defensive during the inflation tantrum when both equities and government bonds fell sharply.