Markets last week
In general, it was a relatively quiet start to the trading week, as investors awaited results from the 200 S&P 500 companies which were scheduled to report earnings, including many of the technology giants. In broad terms, the third quarter reporting season in the US and Europe has been positive and this helped drive US and European stockmarkets higher for the fourth consecutive week.
Asia also began the week on a firm footing, although China was mixed following the decision of the People’s Bank of China to inject liquidity into the financial system and state media reports that the trial of a property tax would be extended, without providing further details in terms of the scope.
Equity markets were also supported by hopes of reduced political tensions, with reports circulating that Janet Yellen had a “candid and constructive” call with China’s Vice Premier Liu He to discuss views on the economy and cooperation. The supposed improvement in US and China relations didn’t last long as shortly after this report surfaced, the US banned China Telecom’s American business which prompted a renewed slump in Chinese tech stocks. Meanwhile, the Japanese stockmarket was also offered a temporary boost after local media reported that the ruling LDP may be able to secure a majority in the forthcoming general election.
While the week was positive, the rally in European stocks faded slightly midweek as falling commodity prices and renewed concerns about the region’s economy weighed on sentiment. Germany cut its 2021 economic growth forecast due to demand hesitancy and continuing supply chain constraints.
The big event in the UK was undoubtedly the budget where upward revisions to growth by the UK’s independent Office for Budget Responsibility (OBR) gave Chancellor Rishi Sunak latitude to increase spending and bolster the UK’s finances. UK equities continued to lag however, although gilts rallied strongly as the UK’s Debt Management Office (DMO) cut the amount of gilt sales planned for this fiscal year by more than expected. The DMO forecasts it will issue £194.8bn by the end of the UK fiscal year, down from the £252.6bn projected in April. This reduced supply caused prices to rise and the yield on 10-year gilts to fall from 1.14% at the beginning of the week to as low as 0.98%, before rising slightly.
The week ahead
Wednesday: FOMC rate decision
Our thoughts: it would be astounding if the US Federal Open Market Committee (FOMC) didn’t announce a taper (slowdown) in the pace of asset purchases at next week’s meeting, although markets are more concerned with the timing, pace and composition of the withdrawal of stimulus. In our view, it is highly likely that tapering will begin in mid-December and the reduction in stimulus will be US$15bn per month, comprising US$10bn less US Treasury purchases and US$5bn less Mortgage Backed Securities (MBS) purchases. This means that the asset purchase programme would finish by June 2022. The accompanying statement will also likely be couched in extremely conditional language, making it clear that there isn’t a predestined path for future monetary policy at this stage.
Thursday: Bank of England meeting
Our thoughts: the UK could well become the first of the world’s major central banks to raise interest rates. The Bank of England Governor Andrew Bailey has previously made remarks to the effect that policymakers “will have to act” if they see a risk that inflation expectations begin to rise. Financial markets seem to assume that a rate hike is a “done deal”. However, it is possible that any move is delayed until December as some members of the rate setting Monetary Policy Committee (MPC) may want to see data for the post-furlough labour markets before making any move. Financial markets are currently forecasting rates rising by more than 1% before the end of 2022; we think this expectation is too aggressive and expect the MPC to proceed more slowly. If rates are raised in November, we would expect a 0.15% initial move.
Friday: Germany industrial production
Our thoughts: having registered a 4% contraction in August, it is unlikely that German industrial production will register a particularly strong rebound in September. The fortunes of the German economy remain highly tightly linked to the auto industry and overall, the automotive industry is still operating 40% below its pre-pandemic level, and this explains much of the collapse in German output. Data released by the German car manufacturers’ association suggests there has been little improvement in September. When combined with continuing supply chain bottlenecks and surging energy prices, we suggest that Friday’s production figures are unlikely to show much strength and that Germany’s industrial weakness is likely to be extended.
Markets for the week
|In local currency
|Hong Kong equities
|Emerging market equities
|Government bond yields (yield change in basis points)
|10-year US Treasury
|10-year German Bund
|Commodities (in USD)
|Brent oil (bbl)
|WTI oil (bbl)
|Copper (metric tonne)
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
No change…for now
October’s European Central Bank (ECB) rate decision was always expected to be a quiet prelude to a more contentious December meeting, and so it proved, with the ECB statement on the Asset Purchase Programme adding one comma and moving one other compared to September’s statement. The ECB reiterated its pledge to continue its emergency bond-buying at a “moderately” slower pace compared to the second and third quarters of this year. They also confirmed that the €1.85trn Pandemic Emergency Purchase Programme (PEPP) will continue until at least the end of March 2022 and until such a time as they judge that the coronavirus crisis phase is over.
Financial markets have become ever more doubtful of the ECB’s commitment to ultra-low interest rates given that inflation is now running at 5.5% in Spain and 4.6% in Germany, while inflation expectations for the eurozone are also at their highest level since 1993. December’s ECB meeting will be accompanied by new economic projections which will allow policymakers to recalibrate the expected path of policy support.
While Europe, along with other economies, is being dogged by high inflation, there are numerous ECB officials who believe that the euro area is different to other regions and needs sustained and significant policy support. The deposit rate was left at -0.5% and it was confirmed that interest rates won’t rise until there are projections which show inflation will be sustained above 2%.
At the subsequent press conference, ECB president Christine Lagarde stated that she expects PEPP will end in March, and while anticipating that supply chain bottlenecks will eventually be resolved, believes that this may take a large part of 2022 to correct. Lagarde also highlighted that the market’s view on interest rate rises isn’t in-line with the ECB’s own projections; the market is too hawkish and expects rates to rise well before the ECB believes this will be likely.
Unsurprisingly, the Bank of Japan also left its main policy rates unchanged during the week, but unlike many other central banks, there is little expectation of any tightening of policy in the coming months given Japan’s unique inflation dynamics.
An expected slowdown in growth.
Growth: US economic growth slowed more than expected in the third quarter, although the figures also weren’t as bad as some had feared. GDP expanded at a 2% annualised rate, which follows the 6.7% pace of the second quarter. The slowdown was concentrated in personal consumption, which grew 1.6%, following a 12% surge in the previous quarter. The well-known factors of transportation bottlenecks, rising prices, supply chain disruptions and the persistent threat posed by the delta variant of the coronavirus impacted both goods and services spending.
The slowdown in consumer spending was driven by weaker motor vehicle sales, which subtracted 2.4% from GDP. Motor vehicle output plunged at an annualised 41.6%; excluding auto output, GDP rose 3.5%.
A wider trade deficit – there were record imports of foreign goods – also detracted. Net exports took 1.1% from the growth figures. Inventories added 2%, while business investment was not as robust as previously, with non-residential fixed investment rising at an annualised 1.8%.
Inflation: the core personal consumption expenditure (PCE) price index, an inflation measure which is favoured by the Federal Reserve, remained elevated, but was no worse than expected. Prices increased at a 4.5% annualised rate in the third quarter, compared to 6.1% previously. The year-on-year PCE deflator figures showed prices increasing by 4.4% (headline) and 3.6% (core) with both figures broadly in-line with expectations. The core figure is the highest reading since 1993.
Personal income and spending: personal spending rose 0.6% in September, as outlays for services increased, suggesting that this part of the economy has some momentum as we head towards the end of the year. Meanwhile, personal income fell 1% as government transfer receipts moved sharply lower. There was a 7% decrease in transfer payments from the government due to the end of federal expanded unemployment benefits on 6 September, but wages and salaries climbed 0.8% in September and marked the seventh straight increase. As a result, the savings rate dropped to 7.5%, which is the lowest reading since December 2019.
Housing: sales of new homes increased to the highest level in six months during September. Purchases of new single-family homes increased by 14%, to an 800,000 annualised pace, above expectations of a 756,000 rate. The figures suggest that demand is stabilising after high prices and a lack of inventory pushed the number of contract signings below pre-pandemic levels recently. Of the homes sold in September, nearly one-third had yet to be started, although the report also showed an increase in purchases of newly completed dwellings. New home purchases account for about 10% of the market but are considered as a timelier barometer of housing conditions as they are calculated when contracts are signed, rather than when contracts close which is the case with previously-owned homes.
Capital and durable goods orders: US capital goods orders rose for a seventh consecutive month; core orders i.e. ex aircraft and military hardware, rose 0.8%. Orders for durable goods orders – items meant to last at least 3 years – were down 0.4% reflecting declines in aircraft and cars. Excluding transportation equipment, durable goods orders increased 0.4%. Capital goods shipments, a figure which is used to calculate investment in the GDP figures, jumped 1.4%. That was the biggest gain in 3 months. Unfilled orders for manufactured goods climbed 0.7%, while inventories rose 0.9% for a second month. The backlog demonstrates the ongoing production constraints and long lead times which are being faced by manufacturers.
Surveys: US consumer confidence unexpectedly rose in October for the first time in four months, as concerns around the delta variant appeared to ease. The Conference Board’s index advanced to 113.8, from 109.8, although higher prices could hold back further improvement in sentiment in the coming months. Short-term inflation concerns rose to a 13-year high but, according to the Conference Board, “the proportion of consumers planning to purchase homes, automobiles, and major appliances all increased in October”. The measures of both current conditions and future expectations both rose slightly. The proportion of consumers who said jobs were “plentiful” fell slightly but remained near a pandemic high.
The University of Michigan sentiment index fell to 71.7, from 72.8 in September, while expectations for inflation continued to rise. Expectations for inflation for the next year stand at 4.8%, the highest figure since 2009, although 5-year inflation expectations stand at a more moderate 2.9%. The gauge of current conditions fell to 77.7 in October from 80.1, while future expectations declined to 67.9, from 68.1.
The Richmond Fed’s October Manufacturing Survey came in above expectations with a +12 reading, against the +3 forecast and well in excess of last month’s -3. New order volumes were reported to have increased, but so too were order backlogs (+19 v +12 in the prior month). Inventory levels of finished goods increased to -11, after the -14 reading last month, while inventory levels of raw goods fell to -21 after -19 last month.
Improved economic forecasts
Budget: the big event of the week in the UK was the budget, delivered by the Chancellor of the Exchequer, Rishi Sunak. The Chancellor’s firepower was boosted by a significantly improved outlook for the UK economy presented by the Office of Budget Responsibility (OBR). The economic growth forecast for the UK in 2021 was increased to 6.5%, from 4%. The actual growth figure may be even higher given the OBR needed to provide this forecast before there were large upward revisions to certain metrics which feed through to GDP. The Bank of England expects 7.25% growth.
Inflation is expected to reach 4.4% in 2022, after which it is forecast to return towards the Bank of England’s 2% target, but risks are still tilted to the upside. Since that initial forecast was made, the OBR has suggested that news released would be consistent with inflation peaking at close to 5% and set out a potential case where more durable inflation feeds through to wage increases and, in that scenario, inflation could peak at 5.4%, which would be a three-decade high, before falling back more slowly.
It was signalled that the UK’s finances need to be repaired given the spending which was necessary to get the economy through the pandemic. Consequently, new fiscal rules have been established which mean that, in normal times, the government will only borrow to invest with day-to-day spending met by taxes and that net debt must be falling as a percentage of output. Both conditions must be met by the third year of every forecast period.
Credit: the value of mortgage lending rose to £9.52bn in September, the most since June when a flurry of deals were completed before a tax break on property purchases was scaled back. September’s figure was well above the £6.8bn six-month average which suggests that underlying property demand remains strong. UK mortgage approvals, however, fell to 72,645 from 74,214 in August although this remains above pre-pandemic rates.
German auto manufacture is depressing activity.
Growth: economic growth in the euro area accelerated in the third quarter; quarter-on-quarter GDP growth reached 2.2%, slightly ahead of economists’ expectations, while the year-on-year figure reached 3.7%. The figures were boosted by better-than-expected growth in France and Italy, with a surge in consumer spending in France lifting output, while Italy’s growth was aided by industry and services. Growth also accelerated in Germany and Spain.
Inflation: the positive GDP picture was overshadowed by inflation figures which were released at the same time, which showed year-on-year CPI accelerating to 4.1%, from 3.4%, while core CPI rose 2.1% on an annual basis, higher than September’s 1.9%. The inflation figures are the main focus of the European Central Bank (ECB).
Survey: German business confidence took a hit in October, with the IFO Index falling for the fourth month in a row to 97.7. It is now at its lowest level in six months. The expectations component also slumped to 95.4, which isn’t particularly surprising given that German businesses are particularly exposed to supply chain disruptions given the country’s reliance on industry, and autos in particular. There is some evidence that this weakness is spilling over into services as consumers are wary of rising prices.
The Bundesbank have also forecast that growth will slow considerably in the fourth quarter and that Germany’s economy is no longer expected to reach 2019’s output level this autumn as had previously been expected.
The European Commission’s monthly sentiment survey showed an unexpected improvement in economic confidence in October, with the index rising to 118.6, from 117.8. Optimism in the services industry was particularly pronounced, although there were also increases in construction and retail trades. Meanwhile, consumers became more pessimistic with widespread concerns around the economic outlook and their future financial situation. The report also highlighted that supply shortages and difficulty in recruiting workers were widespread issues facing businesses. Selling price expectations surged across all sectors of the economy and reached record highs.
Japan’s inflation dynamics are unique.
China: Chinese profit growth at industrial firms accelerated in September, which was partly due to a significant surge in profitability from companies which mine and manufacture raw materials. Profits at petroleum, coal and fuel processing industries grew 930% in the January-September period from a year earlier. As a whole, industrial profit growth accelerated to 16.3% in September (compared to 10.1% in the previous month); over the first nine months of the year, profits rose 44.7% from a year earlier. Profits at state owned companies grew 77.9% year on year in the first nine months of 2021, while those at private firms increased 30.7%.
China also released PMI figures which confirmed further weakness in the economy in October, with power shortages and rising commodity prices dampening manufacturing activity. The composite PMI fell from 51.7 to 50.8 (still slightly above the boom-bust threshold of 50), while the manufacturing PMI fell to 49.2 from 49.6. The service PMI still held above 50 but slipped to 52.4 from 53.2. While the manufacturing side of the economy has been hit by energy shortages and raw material costs, services have been impacted by the government’s zero approach to COVID-19 which has meant a tightening of restrictions around travel and social gatherings and that in turn has meant that consumer spending remains weak.
Japan: Head of the Bank of Japan, Haruhiko Kuroda, signalled there is little chance of policy being tightened as the country’s inflation is highly unlikely to accelerate in the same way as other developed economies. These comments came as the central bank also lowered its growth and inflation forecast, with inflation now expected to be at zero in March next year, compared to the previous 0.6% forecast. Inflation is then expected to reach 0.9% in the fiscal year 2022, and 1% in 2023. Growth forecasts were revised slightly lower for 2021 (3.4% v 3.8%), and then 2.9% in 2022 (previously 2.7%). Kuroda highlighted three reasons why Japan’s inflation will pick up more slowly than other economies; a delayed demand recovery, greater job security during the pandemic and therefore less wage pressures from re-hiring and firms’ reluctance to pass on increased costs to consumers.
Industrial production fell for a third consecutive month in September, with falling output from Japanese auto manufacturers sending factory production down 5.4% month-on-month. The car industry is a key pillar of the Japanese economy and continued supply bottlenecks leaves Japanese economic performance vulnerable to further disappointment. On a quarterly basis, production fell 3.7% from the previous three-months, which makes this the worst quarter for Japanese manufacturing since 2011.
CPI in Tokyo barely remained above zero in October (0.1% year-on-year) which demonstrates the different inflation dynamics in play within the Japanese economy compared to other developed economies.
Oil fell after it was reported that stockpiles increased more than expected last week The American Petroleum Institute reported a 2.32-million-barrel gain on Tuesday, although inventories at the biggest storage hub at Cushing, Oklahoma fell by a more than expected 3.8 million barrels, the most since January. Oil was also undermined as it was reported that Iran and the EU agreed to restart negotiations to revive the 2015 nuclear deal by the end of November.