Markets last week
In a week dominated by central banks, with meetings of the US, eurozone and Japanese monetary authorities, and moves from the People’s Bank of China, the reactions to their actions and statements were quite varied. Risk-on fully returned, and last week was one of the strongest for global equities since the rebound from the Silicon Valley Bank turmoil in March (at least in US dollars). In addition, Artificial Intelligence continued to feed into investor animal spirits. Part of the exuberance was also due to bets that the Chinese authorities would stimulate their economy much more, after a few small cuts in interest rates, going against the rest of the world.
The US inflation print was interpreted generously. Headline consumer price index (CPI) fell below estimates, but core CPI, which is more relevant to central banks, was higher than expected, and yet, the net impact on markets was positive. The meeting of the US Federal Reserve (Fed) the next day was taken as further proof that things were better for risk assets. The Fed was very careful to paint the “skip” in interest rate hikes last week as a short-term, reflection pause, and emphasised its commitment to fighting inflation with another two rate increases this year. Despite this, and the Fed fund futures acknowledging part of the new interest rate forecast, equities quickly assumed that this was the end of the rate raising cycle. Economic data are starting to show a better tone in surveys, in particular in the US, with consumer sentiment improving as well, which has obviously boosted equities.
It is difficult to understate how much bond yields have been rising recently. Last week alone, UK gilts and eurozone government bonds increased by 17 and 10 bps respectively. In fact, gilt prices fell to levels last seen during the Global Financial Crisis. Bank of England future markets are now pricing in 1.25% of additional rate hikes between now and year-end, the highest projected upside among bank rates in developed countries, partly caused by fast-growing wages in the UK. As a result, the two-year gilt yield jumped to 4.84%, the highest since 2008, with the 10-year gilt yield more than 40 bps below that level; an inversion in the yield curve, which is normally the harbinger of a recession. Despite a weak underlying UK economy beset by higher inflation than its neighbours, sterling ended up being the strongest currency last week.
Indeed, the US dollar weakened across the board, as investors are starting to assume no more Fed hikes, despite the Fed’s own statements. Only the Japanese yen lagged behind the US dollar, due to the Bank of Japan’s (BoJ) lack of activity at its meeting.
The incipient share sector rotation seen the previous week continued last week, with materials and industrials not far behind technology, and only energy failing to make any gains. There was a broader rush for equities, almost regardless of their sector, in particular in the US, although the US dollar’s weakness capped many of these returns. Regionally, Europe and China did best, as there seems to be a desire from market participants to see a bigger stimulus from Chinese authorities, but the current moves seem to be piecemeal for the time being.
The week ahead
Wednesday: UK inflation
Our thoughts: the UK is clearly an outlier among developed nations with upper-single-digit inflation. The CPI is expected to fall, but only modestly, and the core CPI (ex. energy, food, alcohol, and tobacco) is seen as being unchanged. The producer price index (PPI) data are estimated to be more cheerful, with both the PPI input and output expected to slump. We have, however, seen that in other countries it takes a long time for PPI moves to feed into consumer prices, so it could be that we once again face a difficult inflation print in the UK. Will that matter to markets, which are already pricing in 1.25% of extra Bank of England (BoE) hikes by year-end? At some point, negative expectations must be fully reflected in markets.
Thursday: Bank of England policy decision
Our thoughts: the next day, the BoE Monetary Policy Committee (MPC) meets and is expected once again to deliver an interest rate hike of 25 bps. Is there any risk to that outcome? Probably not, but the voting patterns among the nine MPC members will be closely followed. The commentary might make some waves in markets, but the MPC does not give forward guidance the way the Fed does, so investor impact could be subdued.
Friday: manufacturing and services purchasing manager indices (PMIs) in Japan, the UK, eurozone and the US
Our thoughts: it is becoming increasingly tough to figure out whether this cycle is slowing down or accelerating. A slightly softer read on the services sector is expected globally but manufacturing is estimated to be flat, although still in contraction territory. Have the recent improved surveys and data in the US made enough of a move that we could see a stronger manufacturing PMI in the US? This could support the incipient rotation towards cyclical sectors.
The numbers for the week
Central banks/fiscal policy
The Fed’s “hawkish skip”, and European Central Bank’s (ECB) urgent tone contrasts with the Bank of Japan’s “business-as-usual”.
The Fed delivered what was labelled a “hawkish skip”, differentiating the US from the Chinese economy in a monetary policy stance that saw them skipping raising rates this month. Despite the skip, the Fed promised more tightening ahead, in fact more than the market was expecting, namely 50 bps instead of 25 bps. The comments were not the only aspects of the meeting that stirred markets, but also the changes in economic projections and the so-called “dot plots” (future rates as seen by all the Fed officials).
Economic forecasts upgraded growth for this year and next, from a mild recession to low expansion. Inflation projections show a small drop in headline personal consumption expenditures (PCE) but an increase in the core PCE, which is the Fed’s gauge. Indeed, Fed Chair Jerome Powell stressed that inflation risks are still on the upside. Unemployment is not expected to rise as much as previously. The “dot plots” indicate another two 25 bp hikes, and no cuts at all this year. This is more hawkish than the market was (and still is) anticipating.
The ECB raised rates by 25 bps and said that another 25 bp increase was “very likely” at its meeting in July, with ECB President Christine Lagarde adding that there was a “very, very broad consensus” on continuing with the hikes, and that they haven’t even thought about pausing. Quite a few ECB officials commented on further rate increases following the announcement.
Andrew Bailey, Governor of the Bank of England, said that “inflation is taking a lot longer” to come down than expected. “We’ve got a very tight labour market”.
At the other end of the spectrum, the BoJ left interest rates and bond market yield curve control unchanged, maintaining their view that inflation will eventually slow down. The policy balance rate stayed at -0.1%, and the 10-year yield target for Japanese Government Bonds remained at 0.0%.
After cutting the seven-day reverse repo rate from 2.0% to 1.9%, the People’s Bank of China (PBoC) cut its medium-term lending facility by 0.10% to 2.65% for the one-year rate, the first such cut since August of last year. After 0.1% reductions this week, the five-year loan prime rate now stands at 4.20%, and the one-year loan prime rate at 3.55%.
Better surveys and data but jobless claims stay on an upward trend
Surveys: a contrast between a better Empire manufacturing survey and a worse Philadelphia Fed Business Outlook. The Empire manufacturing survey (NY State) recovered sharply from -31.8 to +6.6, whereas the Philadelphia Fed survey fell further from -10.4 to -13.7. These two surveys are normally paired as a bellwether for the US economy. Both have exhibited strong volatility, and the previous negative Empire reading looks like an outlier.
The New York Fed services business activity index improved from -16.8 to -5.2.
The University of Michigan sentiment survey surged from 59.2 to 63.9, with current conditions up from 64.9 to 68.0 and expectations from 55.4 to 61.3.
Industry: capacity utilisation fell from 79.8% to 79.6% in May as manufacturing production was up 0.1%, down from +0.9% the prior month.
Employment: initial jobless claims remained at 262K, whereas continuing claims rose from 1755K to 1775K.
Inflation: the import price index in May fell 0.6%, for a -5.9% move year-on-year, down from -4.9%. Likewise, the export price index was down 10.1%, vs. -6.0% previously. The University of Michigan inflation expectations survey fell sharply from 4.2% to 3.3% for one-year inflation and eased from 3.1% to 3.0% for five-to-ten-year inflation.
Consumer: retail sales had a strong May, up 0.3%, following +0.4%. Ex auto and gasoline, they were up 0.4%.
Tight employment leading to higher earnings
Employment: as usual, different dates for the UK report and the International Labour Organisation (ILO) report. The May UK report shows a slightly lower claimant count rate, at 3.9% vs. 4.0%, a negative jobless claims change of -13.6K (i.e., job creation) and the pay rolled employees monthly up 23K, after a massive upward revision for the previous month from a negative to a positive number. The April ILO data show unemployment falling from 3.9% to 3.8%, against estimates of a rise.
Growth: a better April following a weak March, with 0.2% GDP growth, driven by the index of services up 0.3%, but other parts of the economy were weaker: industrial production and its sub-segment manufacturing production were both down 0.3%, and the construction output fell 0.6%, although there was an improvement in the trade balance.
Inflation: average weekly earnings for three months year-on-year increased from 6.1% to 6.5%, and ex. Bonus, from 6.8% to 7.2%. The BoE/Ipsos inflation projection for the next 12 months fell from 3.9% to 3.5%, a far cry from the current rate.
Surveys: the ZEW eurozone expectations survey was a tad lower at -10 vs. -9.4, although the expectations were better in Germany, at -8.5 vs. -10.7. The German current situation, however, tumbled from -34.8 to -56.5.
Industry: eurozone industrial production rose 1.0% in April, up from a negative -3.8% previously.
Foreign trade: the eurozone trade balance surprisingly swung from a surplus of €14 billion to a deficit of €7.1 billion in April.
Chinese economy undoubtedly weaker than government wants it
China: youth unemployment reached a record 20.8%, up from 20.4% and four times the 5.2% surveyed jobless rate. This was probably a major factor behind the PBoC cutting the medium-term lending facility rates.
The May data release highlighted the ongoing weakness of the economy. Industrial production fell from 5.6% year-on-year to 3.5%, retail sales from 18.4% to 12.7%, fixed assets ex. rural, namely investment, from 4.7% to 4.0%, and property investment also from -6.2% to -7.2%. Money supply growth eased from 12.4% to 11.6% for M2, and from 10.7% to 9.6% for M0. Foreign Direct Investment year-on-year fell from 2.2% to 0.1% in May.
Japan: exports and imports both dropped, exports from +2.6% year-on-year to +0.6%, and imports from -2.3% to -9.9%. Core machine orders bounced back 5.5% in April, after -3.9% the prior month. The tertiary industry index (i.e. services), also recovered from -1.5% to +1.2%..
Weaker dollar helps commodities but not gold
A much weaker US dollar generally acted as a tailwind for most commodity prices, with oil rebounding more than 2%, and industrial metals enjoying a better tone. Copper has also benefited from the Chinese policy stimulus announced during the week.
Gold prices, however, were hit following the Fed’s meeting on Tuesday in the expectation of higher interest rates.