Markets last week
Once again, there were divergent moves in markets and economies creating day-to-day volatility for investors, but the general direction was still mostly positive, with surging oil prices and a strong US dollar as the backdrop.
A negative growth surprise in the UK and a reversal of industrial production in the eurozone drove a risk-off environment early in the week, although it was a short-lived sentiment. The US Consumer Price Index (CPI) changed the mood. It was technically higher than expected with some still sticky service prices and a recovery in the energy component which had been driving the headline reading down over the last few months. Markets did, however, interpret them more positively and a higher Producer Price Index (PPI) did not change that buoyant feeling. On Friday, however, the much lower inflation expectations from the University of Michigan sentiment index dragged US equities down, creating a contrarian view in markets about inflation surprises.
The European Central Bank (ECB) delivered yet another 25 bp rates hike with some expectation of a possible pause at the next meeting, although as usual, there wasn’t a lot of guidance from the commentary. The ECB forecast, however, showed lower growth and higher inflation this year and next. Investors seemed to be reassured by the outcome of the meeting with stronger equity returns and bond yields falling, although the euro fell against both the US dollar and sterling.
There was some good news from the Chinese economy after a long string of disappointing data. Industrial production and retail sales bounced back, although the property sector and foreign direct investment were still looking challenged. The improvement nevertheless gave Asian markets some support during the week.
The US dollar and oil prices were very strong last week. The US crude gauge, West Texas Intermediate (WTI) crossed over US$90/bbl, a 15-month high, whilst the global benchmark, Brent, also surged more than 3.5%.
There was some divergence in global government bond yields, with US yields rising against UK and eurozone yields falling, partly reflecting a reassessment on how far central banks are likely to raise rates.
Widespread talk of a US government shutdown, as well as the United Auto Workers strike against Detroit carmakers did not affect the market risk appetite during the week.
At the end of the week, equities performed well but with significant regional and sectoral differences. Japanese and UK shares rose more than 3% whilst US and Chinese markets barely made a positive return. A mixture of sectors was at the top, with financials, utilities and consumer discretionary leading, whereas technology continued on its post-July correction.
The week ahead
Wednesday: UK inflation
Our thoughts: inflation has been very disappointing in the UK and economists are forecasting perhaps a higher reading for August compared to July. Certainly, the level of weekly earnings has been very high and sticky and worried some Bank of England (BoE) officials. Whether there is a silver lining on the data that could stop the BoE from hiking rates further, is probably wishful thinking at this stage, but the recent comment made by BoE Governor Andrew Bailey on being close to the rate peak may resonate with the Monetary Policy Committee (MPC) in general when they come to their interest rate decision. The global backdrop has indicated a stalling or even reversing of the fall in inflation rates. Will the same happen in the UK despite price rises being at a higher level than in other developed countries?
Wednesday: US Federal Reserve (Fed) meeting
Our thoughts: will the Fed hike rates or pause? The current rate (5.25%-5.50%) is already seen as being restrictive enough by many economists, but the markets are assigning a minimal 50% chance of a further rate increase this week and a less than 50% probability of a hike by year-end. Clearly, the current Fed funds rate is not slowing down the US economy in the way that many had anticipated, and the question remains whether the ‘lags’ in monetary policy will eventually bring the US economy to a standstill or whether higher rates are needed. As usual with the Fed, the comments from Fed Chair Jay Powell will matter as much as the rate decision, as investors will be trying to figure out whether more hikes are ahead and how soon the Fed could start cutting rates.
Friday: Purchasing Manager Indices (PMI) for Japan, UK, eurozone and US
Our thoughts: does growth matter again? After markets fixated on central bank rates, the recent softness in US employment data has rekindled the ‘bad news is good‘ market discourse, but is this still true? Will markets take heart with any improvement in the PMIs? Right now, manufacturing is depressed globally but there seems to have been a small bounce in places like the US and Japan, although not in Europe or the UK. Services have been more resilient, with the US, and particularly Japan, above the 50 threshold between expansion and contraction. Will anything change over the last month and what are the implications for global growth? Will markets react as if ‘bad news is good‘ or will they revert to enjoying better growth?
The numbers for the week
Central banks/fiscal policy
The ECB delivers another hike, weakening the euro and eurozone bond yields, but do the comments hint that it is the last one?
The ECB hiked rates by another 25 bps, the tenth consecutive increase, to their all-time high, with the deposit facility rising to 4.00%, the main refinancing rate to 4.50% and the marginal lending facility to 4.75%. The ECB cut growth forecasts for every year until 2025, with a 2023 growth of 0.7%, a 2024 forecast of 1.0% and a 2025 forecast of 1.5%. The ECB also sees the average eurozone inflation rate rising in 2023 to 5.6%, to 3.2% in 2024 but down to 2.1% in 2025. Comments made included inflation is too high and has been too high for too long. The statement indicated that ‘key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.’
The People’s Bank of China (PBoC) cut its reserve requirement ratio for major banks from 10.75% to 10.50%, in a further attempt to stimulate the weak Chinese economy, but it left the one-year medium-term lending facility rate unchanged at 2.50%.
Conflicting statistics on inflation data and expectations. Mixed data with strong retail sales and industrial production but diverging surveys.
Inflation: the all-important CPI rose from 3.2% to 3.7%, somewhat above estimates due to energy costs ceasing to be so negative and services prices still quite sticky. The core CPI ex food and energy, however, fell from 4.7% to 4.3%. The PPI rose from 0.8% to 1.6% for the PPI final demand, eased from 2.4% to 2.2% for the PPI ex food and energy but climbed further from 2.9% to 3.0% for the PPI ex food, energy and trade.
Real average hourly earnings were up 0.5% year-on-year and the real average weekly earnings rose 0.3%.
The New York Fed one-year inflation expectations survey edged up from 3.55% to 3.63%.
Import prices in August were higher, up 0.5% from 0.1% previously, i.e. -3.0% year-on-year up from -4.6%, but ex petroleum remained flat on the month. Export prices jumped 1.3% in August for -5.5% year-on-year, up from -8.0%.
Inflation expectations embedded within the University of Michigan sentiment index fell quite sharply with one-year inflation expectations down to 3.1% from 3.5% and 5-10-year inflation to 2.7% from 3.0%.
Employment: the weekly jobless claims series continues to show lower claims after a peak in June, with initial claims at 220K vs. 217K the previous week, and continuing claims at 1688K vs. 1684K.
Surveys: the National Federation of Independent Business (NFIB) small business optimism index lost some ground, from 91.9 to 91.3, a weak reading but still above the cyclical low of 89 earlier this year.
The Empire Manufacturing survey (New York State) bounced back above estimates from -19.0 to +1.9.
The University of Michigan sentiment index fell from 69.5 to 67.7, driven by current conditions down from 75.7 to 69.8, although expectations edged up from 65.5 to 66.3.
Industry: business inventories were flat in July after -0.1% the prior month. Capacity utilisation in August continued its rally, from 79.3%, upgraded to 79.5% last month and this month up further to 79.7%. Industrial production in August rose 0.4% after +0.7% the prior month.
Consumer: retail sales in August rose 0.6%, above estimates and above the previous month’s reading of 0.5%, retail sales ex auto and gasoline were softer, though, at +0.2% vs. +0.7%.
Negative growth in July, a steep drop in house prices and disappointing inflation expectations.
Growth: Gross Domestic Product (GDP) growth had a disappointing month in July, dropping 0.5% after a positive 0.5% the prior month. The shortfall was mostly driven by manufacturing production falling 0.8% but also the index of services surprisingly down 0.5%. Construction output was also negative 0.5% but the trade balance improved. Over the last three months, GDP continued to rise 0.2%, as previously, meaning that June’s upward surprise was offset by July’s downward move.
Employment: the two different employment surveys (from the UK Office of National Statistics (ONS) and the International Labour Organisation (ILO) showed little change in the jobs picture in the UK. The ONS August data had an unchanged claimant count rate at 4.0%, a jobless claim change of 0.9K, down from 7.3K and a payrolled employees monthly change of -1K vs. -4K. The ILO July numbers saw a small increase in the three month unemployment rate from 4.2% to 4.3%, a large drop in employment from -66K to -195K and the average weekly earnings up 8.5% year-on-year (from 8.4% the prior month) and 7.8% ex-bonus (unchanged).
Housing: the Royal Institution of Chartered Surveyors (RICS) said that almost every region in the UK is now seeing ‘relatively steep‘ falls in house prices. The RICS house price balance index is the most negative since 2009, down from -55% to -68%. The Rightmove house price index rose 0.4% in September for a year-on-year fall of 0.4%, below the prior month at -0.1%.
Inflation: the BoE/Ipsos inflation expectations for the next 12 months rose to 3.6% from 3.5%.
Very poor growth and surveys
Surveys: the Zentrum für Europäische Wirtschaftsforschung (ZEW) survey was more negative for the eurozone, with the expectations component down from -5.5 to -8.9, but the expectations for Germany a tad better at -11.4 vs. -12.3. The German current situation, however, was markedly worse at -79.4 vs. -71.3.
Industry: industrial production in the eurozone fell sharply in July, down 1.1% for the month and -2.2% year-on-year, down from -1.1% the previous month.
Inflation: German wholesale prices were slightly less negative at -2.7% vs. -2.8%.
A mixed bag of monthly data in China, but a few rays of sunshine helped investor mood. Some concerns about Japanese machine orders.
China: the August economic data release was generally better than expected and seemed to point towards some kind of economic stabilisation if not rebound. New home prices fell 0.29% after -0.23% the prior month, industrial production recovered from 3.7% year-to-date to 4.5%, retail sales from 2.5% to 4.6%, fixed assets ex rural (i.e. investment) eased from 3.4% to 3.2%, property investment from -8.5% to -8.8% and residential property sales dropped from +0.7% to -1.5%. The surveyed jobless rate improved from 5.3% to 5.2%. Foreign direct investment, however, fell further from -4.0% year-on-year to -5.1%.
Japan: the PPI fell a little from 3.4% to 3.2% year-on-year. Core machine orders (which are more domestically focused than machine tool orders) fell 1.1% in July for a year-on-year drop of -13.0% vs. -5.8% previously. Capacity utilisation fell 2.2% in July, after a positive 3.8% the prior month. The tertiary industry index (i.e. services) rebounded from -0.7% to +0.9% in July.
Oil still riding high, even as the US dollar strengthens
Saudi Arabia extended its crude oil output cuts until the end of the year. Organisation of the Petroleum Exporting Countries (OPEC) announced that global oil markets face a supply shortfall of more than three million barrels by year-end, the largest production shortfall in over a decade. The news further supported the already bullish crude prices.
Despite industrial metals prices lagging the strong energy trend, iron ore has quietly reached a five-month high.