Markets last week
Inflation came back to the fore last week, with two surprisingly high readings for the consumer price index in the US and the UK. The heads of the respective central banks took pains to explain that this would not change monetary policy in either country, but markets were somewhat sceptical. Indeed, two members of the Bank of England’s Monetary Policy Committee openly disagreed with Governor Andrew Bailey’s patient views on inflation and hence gilt yields rose in expectation of an earlier change to quantitative easing and interest rates. Likewise, James Bullard of the St Louis Fed called upon Federal Reserve Chair Jay Powell to start the tapering of Fed purchases of government and mortgage bonds.
Economic data were still buoyant, with Chinese growth numbers at very high levels and most surveys globally indicating a continuation of strong growth.
The highly contagious Delta variant now accounts for more than 51% of COVID-19 cases in the US. Public health officials are urging the roughly 140 million to 150 million people who remain unvaccinated to get vaccinated. It is not yet clear what economic impact, if any, will be wrought by this variant in the US, Europe or anywhere else.
After under-performing US and European markets for most of this year, Asian equities were the leaders last week, eking out positive returns whilst UK and European shares fell. The Bank of England followed the European Central Bank in allowing higher dividend payouts for banks. It did not help financial shares enough. The best performing sectors last week were the defensive ones (utilities, consumer staples, real estate) whereas energy was the biggest loser, in part due to the agreement within OPEC+ which paves the way for output additions.
Government bond yields were generally lower. Oil and copper prices suffered whilst gold was supported by the inflation data.
The week ahead
Wednesday: UK public finances
Our thoughts: the Chancellor’s autumn budget threw up some eye-watering spending and borrowing targets for the UK. Since then, it looks like public finances have been less profligate than expected, not because less spending has been forthcoming but because higher tax revenues have come in. Given the massive uncertainty around the unwinding of the furlough scheme this autumn, the Exchequer would clearly like to have some flexibility in extending certain schemes if required. Another month of improving public finances and lower deficits than estimated would be highly welcome against that backdrop.
Thursday: European Central Bank (ECB) meeting
Our thoughts: ECB President Christine Lagarde has warned us that a change of policy is afoot. Is it the heavily-leaked copy of the Fed’s Average Interest Rate policy or is there another twist to the tale? At a time when the Fed is widely expected to start tapering its purchases of government and mortgage bonds, the fullest support from the other two mega-central banks, the ECB and the BoJ (Bank of Japan) would be meaningful for global liquidity. If the ECB is expected to be patient with rates and QE (quantitative easing), then risk markets in Europe and elsewhere will benefit. The devil may be in the details, but the policy announcement from the ECB is likely to have an impact.
Friday: Markit manufacturing and services PMIs in the UK, Eurozone and US
Our thoughts: there has been a lot of market talk about ’peak growth.’ Also, historically, equities have reacted somewhat negatively to ’peak PMIs.’ The concern is that we may have seen the best of growth recovery and from now on, markets will suffer because the economy will perform less well than during the second quarter. Right now, the expectation is for both the manufacturing and services PMIs to be above 60 in the US, the Eurozone and the UK, a very unusual favourable alignment of the economic stars. The longer PMIs remain at a high level, the more likely that peak growth will turn out to be a damp squib for the markets, i.e. that growth can remain high for longer than expected. The existence of bottlenecks, supply chain issues and skills mismatches may very well work in favour of extending the economic recovery due to unfilled orders and backlogs. The combination of strong manufacturing and services PMIs is also very rare, as one part of the economy tends to lead the other at any time.
The numbers for the week
|In local currency||In sterling|
|Index||Last week||YTD||Last week||YTD|
|Hong Kong equities||2.40%||2.80%||3.00%||1.70%|
|Emerging market equities||1.70%||3.80%||2.30%||2.80%|
|Government bond yields (yield change in basis points)|
|Current level||Last week||YTD|
|10-year US Treasury||1.29%||-7||38|
|10-year German Bund||-0.35%||-6||22|
|Current level||Last week||YTD|
|Commodities (in USD)|
|Current level||Last week||YTD|
|Brent oil (bbl)||73.59||-2.60%||42.10%|
|WTI oil (bbl)||71.81||-3.70%||48.00%|
|Copper (metric tonne)||9427||-1.00%||21.40%|
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Both the Fed and BoE heads call for cool heads on inflation, but other members don’t stick to the script
The biggest UK banks will be able to increase dividend payouts after the Bank of England (BoE) removed restrictions. The central bank concluded the industry now has enough capital to resume payments as they wish.
BoE Governor Andrew Bailey reiterated the bank’s policy on inflation after the higher UK consumer price index print: “Today’s number – yes, it was higher than we thought it would be, it’s higher than pretty much most observers thought would be in that sense. What we will have to do, again, is go through all the evidence and assess to what extent we think the sorts of things that underlie that are likely to be transitory.” Michael Saunders and Deputy Governor Sir David Ramsden noted that growth and inflation in the UK have exceeded the central bank’s latest forecasts in May. Saunders said the BoE may have to consider curtailing its stimulus programme “in the next month or two” to contain inflation as the economy rebounds. Dave Ramsden projected that inflation might rise to 4% and that he could “envisage those conditions for considering tightening being met somewhat sooner than I had previously thought.”
Federal Reserve (Fed) Chair Jerome Powell said it was still too soon to scale back the central bank’s aggressive support for the US economy, despite inflation rising faster than expected. “At our June meeting, the committee discussed the economy’s progress toward our goals since we adopted our asset purchase guidance last December. While reaching the standard of ‘substantial further progress’ is still a ways (sic) off, participants expect that progress will continue. Even after this supply comes, it is still likely that we will still be short of maximum employment. That is why we don’t see that is time to raise interest rates now. Measures of longer-term inflation expectations have moved up from their pandemic lows and are in a range that is broadly consistent with the FOMC’s longer-run inflation goal,” stressing that the largest gains in inflation stemmed from a small group of goods and services. He also highlighted that “conditions in the labour market have continued to improve, but there is still a long way to go. Despite substantial improvements for racial and ethnic groups, the hardest-hit groups still have the most ground left to regain.”
St Louis Fed President James Bullard seemed to disagree, saying the Fed has met its goal of achieving “substantial further progress” on both inflation and employment, urging policy makers to move forward in reducing stimulus. “I think we are in a situation where we can taper. We don’t want to jar markets or anything – but I think it is time to end these emergency measures.”
The Biden Administration has moved to introduce a US$3.5trn infrastructure spending bill to Congress. This budget resolution was originally proposed by Senate Democrats on the Budget Committee and seems to be gaining momentum although the hurdles are still high, as the Republicans are not in favour of the legislation.
Eye-watering CPI reading rounds up four months of surging inflation
Inflation: the CPI (consumer price index) jumped 0.9% in June and 5.4% year-on-year. Core CPI ex-food and energy also rose 0.9% and 4.5%year-on-year. The headline CPI is one of the highest in 30 years and core CPI is the highest in three decades.
Used vehicles accounted for one third of the gain. Other outsize gains included hotel stays, car rentals, apparel and airfares. The cost of food away from home jumped 0.7%, the largest gain since 1981.
Shelter inflation is the single biggest component of the CPI. Overall shelter costs still increased 0.49% and 2.58% year-on-year, but a large part of the jump was caused by lodging away from home which surged 15%, including a 7.9% jump in hotel stays.
Wage inflation appears to be under control. Most measures of wage inflation are running below their average for the last five years, with the Atlanta Fed putting overall wage growth at 3.2% (it was 3.7% before COVID-19) but the National Federation of Independent Business (NFIB) finds the highest proportion of its members raising pay since they started asking the question in 1984 and also 47% of them, the largest share since 1981, reported higher selling prices in June.
The PPI (producer price index) increased 1% in June and 7.3% year-on-year. Excluding volatile food and energy components, the so-called core PPI also rose 1%, and was up 5.6% year-on-year.
The University of Michigan expected inflation rose from 4.2% to 4.8% and the 5-10-year reading also edged up from 2.8% to 2.9%.
Lastly, the import price index rose 1% in June to 11.2% year on year, down from 11.6% whereas the export price index rose 1.2% in June for a 16.8% year-on-year growth, down from 17.5%.
Surveys: the NFIB Small Business Optimism Index rose from 99.6 to 102.5. The Empire State Manufacturing Survey soared from 17.4 to 43.0 whereas the Philadelphia Fed Business Outlook Survey (Philly Fed) slumped from 30.7 to 21.9. The University of Michigan fell from 85.5 to 80.8, with both current conditions and expectations contributing to the drop.
Housing: MBA mortgage applications surged 19% during the week of 9 July, following some weak numbers since February.
Industry: industrial production rose 0.4% in June, down from 0.7% the previous month and below estimates, with manufacturing the major disappointment, down 0.1%. Capacity utilisation edged up from 75.1% to 75.4% in June, still way down from a pre-COVID-19 77% and 2018 peak of 80%.
Employment: initial jobless claims fell from 386K to 360K, a post-COVID-19 low albeit above estimates, and continuing claims fell more sharply from 3367K to 3241K.
Sales: retail sales rose 0.6% in June or 1.3% ex auto, but sales are now up 20% over 2019 levels.
Higher inflation but also employment
Inflation: the CPI (consumer price index) climbed to 2.5%, the highest since August 2018. Prices for food, used cars, clothing and footwear, eating and drinking out and fuel rose in 2021 and, as they fell in 2020, they provided the largest upward contributions to the change in the inflation rate. Motor fuel costs rose 20.3%, the most in more than a decade. Prices for used vehicles rose 4.4% in the month of June, the strongest recorded since records began in 1996.
Employment: UK companies added payrolls at a record pace in June due to the reopening of the economy. The number of employees climbed by 356,000 following a 212,000 surge in May. The jobless rate, which has been held down by the government’s furlough programme, rose to 4.8% in the three months to May, only marginally above where it was before the pandemic struck.
Retail sales: the BRC (British Retail Consortium) sales like-for-like were up 6.7% year-on-year in June, down from a high 18.5% the previous month.
Housing: the UK house price index (average price for all dwellings) for May rose 10% year-on-year, a high since 2007, up from 9.6% the previous month.
Auto sector not recovering fully
Production: eurozone industrial production fell 1% in May, bringing the year-on-year increase to 20.5%, down from 39.4% the previous month. Euro 27 auto registrations rose 13% in June compared with a year ago, bringing the total in the first six months to 6.49 million, a 27% increase from the first half of last year but almost 2 million below two years ago.
Inflation: German CPI (consumer price index) for June was unchanged at 2.1% (EU harmonised) and French CPI was also unchanged at 1.9%. For the eurozone as a whole, the CPI was also unchanged at 1.9% with the core CPI (ex-energy, food, alcohol and tobacco) also stable at 0.9%.
China’s growth may be slowing but is still very strong in various sectors
China: the Chinese trade surplus increased from US$45.5bn to US$51.5bn in June with exports up 32.2% year-on-year and imports 36.7%.
Gross domestic product rose 1.3% in the second quarter from the previous three months and 7.9% year-on-year, down from 18.3% in the previous quarter. The breakdown was better than expected. Industrial output rose 8.3% in June from a year earlier. Retail sales expanded 12.1% and fixed-asset investment climbed 12.6% in the first half from a year ago. The jobless rate was unchanged at 5% at the end of June.
New home prices rose 0.41% in June, down from 0.52% the previous month.
Japan: industrial production fell 6.5% in May, for a year-on-year rise of 21.1%, down from 22% previously. Capacity utilisation fell 6.8% in May, following a 1.1% increase the prior month. The tertiary industry index (services) dropped 2.7% in May following a previous 0.8% fall.
Saudi Arabia and the UAE reached a compromise within OPEC+ to unlock the additional supply after a dispute between both countries, which will add 400,000/day of daily output. The net result was lower crude prices. The higher CPI numbers in the US and UK were a boost to gold prices.