The numbers for the week – 19 Jul 2022

The numbers for the week – 19 Jul 2022

Markets last week

Volatility was never far from the surface last week, with equities, bonds, currencies and commodities all experiencing high levels of daily and even intra-day change. The fundamental moves were triggered by inflation and economic surveys.

Chinese economic growth fell during Q2 with the 12-month GDP barely above 0%, but the details for June looked more hopeful, with only real estate falling but other parts of the Chinese economy doing much better. Also, the bellwether ZEW survey in Germany and the eurozone hit a decade low.

By far the biggest shock to markets, however, came on Wednesday when the US CPI (consumer price index) soared to a high of 9.1%, way above estimates. That statistic was published shortly after the Bank of Canada announced a 1% interest rate hike, which made the US CPI level even more horrendous to investors. Later data seemed to mitigate the impact of that number, in particular on Friday with the University of Michigan inflation expectations falling for both the year ahead and the 5-10-year time frame.

The previous CPI surprise had led the US Federal Reserve (Fed) to up its expected interest rate hike from 50 bps to 75 bps and deliver a 75-bp increase at the June meeting, so markets naturally assumed that the latest inflation surge would force the Fed’s hand to move to 100 bps from the now widely expected 75 bps at their meeting later this month. A foursome of senior Fed members, though, took pains to dispel that view, including one of the most hawkish members, James Bullard, who suggested that 75 bps was enough. These comments helped re-set the market mood from its mid-week pessimism.

By the end of the week, government bond yields had fallen by 15-20 bps across most developed markets, partly on the expectation that a recession in the US and Europe would cause the Fed to stop tightening and reverse course later this year or early next. This was reflected in inverted yield curves (where longer-term yields are lower than some short-term yields, in this case the 10-year yield below both the one-year and two-year yields). The intra-day fixed income moves were quite brutal, especially on the day of the CPI print.

Commodities were also highly volatile. Brent oil fell below US$95/bbl, only to rebound quite sharply and finish the week at US$101 for Brent. Copper and other industrial metals, however, did not cancel their downward trend. Copper prices are now down 26% this year in the clear anticipation of a recession in some important parts of the world. Gold prices moved down in sympathy, falling below US$1,700 at some point and ending the week at US$1,708, a 15-month low in dollar terms.

Currencies were not to be outdone on volatility. The euro briefly dropped below parity with the US dollar, as the US dollar went almost vertical during the week. The single currency was also hurt by Spain raising windfall taxes on banks and energy companies and the Italian government on the verge of collapse. Sterling did not beat the euro, though, whether or not due to the current leadership challenge within the Conservative Party.

Equities had a see-saw week, falling sharply mid-week and recovering by the weekend with a massive rally in Europe and the US on Friday. Most markets ended up with fairly similar flattish returns, with the exception of China. The Q2 GDP drop, a COVID-19 flare-up in Shanghai and some issues between tech giant Ali Baba and the government, all added up to a tough few days for the Hong Kong market. In terms of equity sectors, the week was heavily negative for materials, financials and certain communications names, whereas defensive sectors (consumer staples, utilities, healthcare) were almost unscathed.

The week ahead

Wednesday: UK CPI, RPI and PPI

Our thoughts: after the shockingly high US CPI, UK CPI numbers will be scrutinised carefully, in particular since the markets are awaiting a double-digit number at some point, as forecast by the Bank of England. The UK market is less bothered about core CPI (ex food and energy) compared to the US, but the difference will nevertheless be analysed for sensitivity to energy and food prices. The other numbers that will be worth probing are the PPIs (producer price index) with both an input and an output level. PPI input has exceeded 20% recently and PPI output is above 15%. There doesn’t seem to be any reprieve expected. The Bank of England doesn’t have a predetermined path for interest rates, which means that the volatility of the inflation data will have a more direct correlation to the Monetary Policy Committee’s decision to raise rates further.

Thursday: ECB meeting

Our thoughts: this is the first time that the ECB (European Central Bank) is expected to raise interest rates in this cycle. Whereas the Fed has constantly readjusted the market’s expectations, the ECB has been less hawkish or specific about its future intentions. Starting with a negative interest rate level, the ECB has a much bigger task ahead, but it appears that they are not in a hurry to move to the same levels as the Bank of England, let alone the Fed. Once again, markets will not just react to the numbers but also the rhetoric and any clues on future rate moves. The status of asset purchases will also matter to European markets, especially government bonds, with concerns about how weaker southern European credits are going to finance themselves, compared to Germany and core countries.

Friday (Thursday for Japan): manufacturing and services PMIs for the UK, eurozone, Japan and the US

Our thoughts: markets have moved fast to price not only higher inflation and higher interest rates but also an economic slowdown in most regions of the world.  Although existing economic conditions in most regions have not deteriorated massively, a future downturn is anticipated. The PMI surveys are the economic signals of any upcoming recession and hence will be mined in great detail for their forecasting content. Most CPIs, both manufacturing and services, are expected to fall by roughly one point, remaining above the 50 threshold between expansion and contraction. At this rate, CPIs could fall below 50 broadly by the autumn, signalling an upcoming recession or at least a slowdown. The speed of fall will therefore have an impact on investor sentiment.


The numbers for the week 

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

A consensus on 75 bps by various members for the next US Federal Reserve (Fed) interest rate rise clashes with market expectations of 100 bps

Loretta Mester, Cleveland Fed President, said that the June US CPI print gave no reason to have a smaller rate hike than the currently pencilled-in 75 bps, but she was not so certain about whether 100 bps would be required, arguing that there were still two weeks before that discussion. Federal Reserve Governor Christopher Waller agreed that 75 bps is the right increase later this month but left himself open to change if the data came in stronger. Atlanta Fed President Raphael Bostic said that everything was on the table after a higher-than-expected inflation reading but added that “markets got ahead of themselves” on a 100 bp hike. Interestingly, James Bullard, possibly the most hawkish Fed member, called for ‘moderation’ in rate increases, playing down the possibility of a 100 bp hike. James Bullard did, however, state that he would favour raising rates to 3.75% to 4% during the course of this year, which is a higher level than most other Fed members are suggesting.

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

United States

Was the 9.1% CPI shocker the peak of inflation (according to University of Michigan expectations)?

Surveys: the NFIB survey of Small Business Optimism index slumped to 89.5 from 93.1. On balance, a net -61% of respondents expect that the economic outlook over the next six months will be better, a record low. The Empire Manufacturing survey (NY State) surprised with a rebound to +11.1 from -1.2.  The University of Michigan Sentiment Index unexpectedly bounced back from 50.0 to 51.1, driven by current conditions surging from 53.8 to 57.1 while expectations were little changed at 47.3 vs. 47.5.

Inflation: the CPI soared to 9.1%, from 8.6% previously and above expectations. Although the core CPI was slightly down, at 5.9% from 6%, the headline number shocked consumers and markets alike.

Breaking it down, the CPI for nondurable goods rose 16.2%, with food at 10.4% and energy at 41.6%, whereas durable goods rose 8.4%, down from 11.4% in May. The CPI for services rose 6.2%, up from 5.7% in May.

The PPI was also sharply above estimates, at 11.3%, up from 10.9%, with the PPI ex food and energy at 8.2%, down from 8.5% and the PPI ex food, energy and trade at 6.4%, down from 6.7%.

The import price index eased from 11.6% to 10.7% year-on-year in June with the export price index slightly lower at 18.2% vs. 18.7%.

The University of Michigan inflation expectation fell from 5.3% to 5.2% for one-year inflation, and from 3.1% to 2.8% for 5-10-year inflation.

Industry: industrial production fell 0.2% in June, down from 0% previously, with capacity utilisation easing from 80.3% to 80.0%.  Business inventories rose 1.4% in May, up from 1.3%.

Employment: initial jobless claims rose from 235K to 244K, marking a progressive increase from 166K over the last 4 months. Continuing claims fell from 1372K to 1331K.

Housing: MBA mortgage applications fell another 1.7% over the week, after -5.4% previously.

Consumer:  retail sales in June rose 1.0% after a negative month with the control group strong at +0.8% vs. -0.3%.


United Kingdom

Retail sales and housing soft, but GDP surprises on the upside

Sales: BRC (British Retail Consortium) like-for-like retail sales fell 1.3% in June, the fourth monthly drop in a row.

Growth: May GDP was up a surprising 0.5% with the 3M/3M growth 0.4% up from 0.3% previously. May growth came mostly from manufacturing, up 1.4%, and construction, up 1.5%, with services up 0.1% and the trade deficit almost unchanged.

Housing: the RICS house price balance worsened from 72% to 65%, below estimates.



Dire economic surveys

Surveys: European economic surveys are looking dire, with the ZEW survey expectations component at -51.1 for the eurozone, down from -28.0. For Germany, very similar numbers for the expectations, plus the current situation falling from -27.6 to -45.8. The expectations level is very close to the lows in 2008 and 2011 during the eurozone crisis.

Industry: the eurozone industrial production surprised on the upside in May, rising 0.8%, up from 0.5% the previous month. EU27 new car registrations were down 15.4% in June year-on-year, worse than the prior month.

Taxes: Spain will impose new taxes on large banks and energy companies for two years, raising €1.5bn per year from banks and €2bn from energy companies. Is this a harbinger of other European countries slapping windfall taxes?



Chinese economy weakness driven by real estate, not consumption or investment

China: money supply was stronger than previously, with M0 up 13.8% year-on-year, vs. 13.5%, M1 up 5.8% from 4.6% and M2 up 11.4% from 11.1%.

Exports were up 17.9% year-on-year in June, up from the prior month and better than estimates at 12.5%. At the same time, imports were growing less at 1% vs 4.1%. This shows that the widely anticipated deglobalisation has yet to happen.

GDP fell 2.6% in Q2, below estimates, with year-on-year growth down to a mere 0.4% from 4.8% the previous quarter.

Separately, June data show a big divergence between real estate and the rest of the economy. Retail sales are up 3.1% year-on-year, from a heavily negative previous month, industrial production is up 3.9%, up from 0.7%, fixed assets ex rural (i.e. investment) are up 6.1%, almost unchanged, but property investment is down 5.4% and residential property sales down 31.8%. The surveyed jobless rate fell from 5.9% to 5.5%.

Japan: machine tool orders rose 17.1% year-on-year in June, down from 23.7% previously. The PPI remained high at 9.2% vs. 9.3%, beating expectations. Capacity utilisation fell 9.2% in May after a flat month. The tertiary industry index (i.e. services) rose by 0.8% in May, up from 0.7% previously.


Oil/Commodities/Emerging Markets

Falling commodity prices across the board

Comments by OPEC and the IEA (International Energy Agency) about continuing tight oil supply did not really help crude prices during the week. The Brent gauge fell by 5.5%, despite a sharp recovery at the end of the week, having dropped below US$95/bbl at some point on Thursday. Likewise, copper briefly challenged the US$7,000 level per metric tonne, with other industrial metals also trending downward.

Gold also followed other commodities down, hitting a 15-month low in US dollars, partly offset for non-dollar investors by the strength of the greenback.

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