The numbers for the week – 20 Feb 23
Markets last week
Some important changes in investment sentiment took place last week, which may well have an ongoing effect. US economic growth was clearly much stronger than anticipated, with surging retail sales and recovering manufacturing production against the backdrop of the perennially tight jobs market. This worked both ways on markets, lending increasing confidence to the ‘soft landing’ scenario (i.e. avoiding a recession) and even a ‘no landing’ option (no economic slowdown at all), but also fuelling worries about inflation.
Indeed, investors are starting to be concerned about the rising odds of a second inflation wave, in light of sticky US consumer and producer price indices, driven by seemingly unbending service price rises. Given that context, central bank officials globally commented about the need to keep hiking rates and leaving them higher for longer, in order to slay the inflation dragon in western economies. The US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE) all featured speakers who looked like they were engaging in one-upmanship about the need to continue raising rates.
Some commentators have also been mentioning the traditional lags in monetary policy, given the 4.5% in rate increases by the Fed since the beginning of last year and particularly the string of 75 bp hikes from June. Economic surveys have been highlighting the future risks to the economy from these policy moves despite the US benefiting from massive pandemic savings and very tight employment to support its growth. The most recent such survey was the Philadelphia Fed Business Outlook, whose large drop last week would normally be considered indicative of a future recession.
Over the last week, though, what markets started to notice are the twin pressures from strong data and hawkish central banks. First, US Federal fund futures dropped potential cuts from the Fed funds rate late this year; then they added an additional hike in the next few months. Futures were followed by the US bond market, where long-term bond yields rose to their highest level this year, with the 2-year yield nearing 15-year highs. In the US treasury yield curve, there are now many maturities with rates above 4% with some shorter-term treasuries at 5%. On Thursday and Friday, equities followed suit, with technology and other growth sectors correcting the most, as they have been the biggest beneficiaries of the year-to-date economic optimism. Although bond yields also spiked in Europe and the UK, shares in these countries did not react as much as in the US, due to the much lower percentage of the information technology sector.
Separately, the initial flurry of excitement about the Chinese reopening has given way to renewed geopolitical concerns due to the balloon incident, and led the Asian markets to lag western markets last week. This has not, however, stopped western companies doing business in China from performing strongly, in particular within consumer sectors and luxury products.
All of these moves have been accompanied by a resurgence in the US dollar, leading to drops in commodity prices. Indeed, the dollar has bounced back more than 3% since its low at the beginning of February. Oil and gold prices have both been weak during the last fortnight as a result, although copper has been more resilient, due to ongoing supply issues.
At the end of the week, government bond yields rose by 12 bps for gilts and 8 bps for US treasuries due to a recovery on Friday, the US dollar was slightly higher with sterling lagging the euro, crude oil fell 4% and gold eased 1% but copper rallied 1.5%.
Equities were mixed, with European and UK shares doing best and Asia and emerging markets lagging. Once again, an unusual blend of consumer discretionary, consumer staples, industrials and utilities had the best returns, whereas energy had the worst.
The week ahead
Tuesday: manufacturing and services purchasing manager indices (PMIs) for Japan, UK, eurozone and US
Our thoughts: does growth matter for markets again? The recent improvement in global expectations has led to the belief that a recession can be avoided almost everywhere. The PMIs have generally painted a different picture, with manufacturing very much in a recessionary backdrop, whereas services are showing resilience. Is that picture about to change as the weight of past interest rate hikes starts to impact the real economy? Manufacturing PMIs have been below the 50 threshold between expansion and contraction in all four regions, but services have remained above 50 in the eurozone and Japan, with the UK the outlier, surprisingly weaker in manufacturing than services. The direction of the PMIs, the comparison between manufacturing and services and the differences between countries, will all add to the market’s views on future growth.
Thursday: Japanese inflation
Our thoughts: does Japan matter to the rest of the world? Well, when it comes to inflation, it probably does. Consumer prices indices (CPI) have been unexpectedly high in a country not used to inflation. The Bank of Japan (BoJ) has followed the easiest monetary policy in the developed world. Given how much capital Japan exports, especially by buying US treasury bonds, any change to its future rate policy could have a momentous effect. Another significant rise in the CPI could actually lead the incoming Governor of the BoJ to consider hiking rates, a potentially seismic outcome for many global markets. Japanese inflation really matters now.
Friday: US personal consumption expenditures (PCE) inflation
Our thoughts: the recent CPI and producer price index (PPI) numbers in the US have disappointed through their stickiness. The real gauge for the Fed, though, is the core PCE, which currently lies at 4.4% vs. a 5.0% headline PCE level. The January number will be eagerly awaited and could move markets, which are now more attuned to the risk of inflation remaining higher than they were earlier this year. The details and comments made by Fed officials will obviously have an impact, too.
The numbers for the week
Central banks/fiscal policy
Consistent message from major central banks on the need to continue the inflation fight
US Federal Reserve Bank (Fed) Cleveland President Loretta Mester said that at the previous Fed meeting she saw a compelling case for a ½ point rate hike: “at this juncture, the incoming data have not changed my view that we will need to bring the Fed funds rate above 5% and hold it there for some time.” She also favoured “overshooting” on policy; “over-tightening also has its costs, but if inflation begins to move faster than anticipated, we can react appropriately….we need to be prepared to move the Federal funds rate higher if the upside risks to inflation are realised and inflation fails to moderate as expected or if the imbalances between demand and supply in product and labour markets persist longer than anticipated.” St Louis Fed President James Bullard also echoed her words about a potential 50 bp hike.
Richmond Fed President Thomas Barkin said he favoured a ¼ point interest rate hike at the next meeting. Fed Governor Michelle Bowman said the Fed should keep raising interest rates, since inflation remains much too high.
Bank of England (BoE) Chief Economist Huw Pill described inflation as a “wicked problem” due to the complex economic environment, and that it was not “job done” for the BoE despite recent improvements in some data.
European Central Bank (ECB) Governing Council member Joachim Nagel says he doesn’t see interest rates at a sufficiently restrictive level yet. “I can’t see that we’re in restrictive territory now and I can’t say exactly where the restrictive territory will be. I’ll make that dependent on what the new projections will look like… inflation can be very persistent. It’s always been a cardinal mistake on the part of monetary policy to let up too soon in such a phase.”
ECB Executive Board member Isabel Schnabel said that markets may be underestimating inflation and if the economy does not react as in the past during tightening cycles, “we may have to act more forcefully… Markets are priced for perception. They assume inflation is going to come down very quickly toward 2% and it is going to stay there, while the economy will do just fine.”
The People’s Bank of China (PBoC) left its one-year medium-term lending facility rate at 2.75%. The 5-year loan prime rate was kept at 4.30% and the one-year loan prime rate at 3.65%.
United States
Inflation stickier than expected at both the consumer and producer levels; jobs still very tight, housing still falling and surveys still mixed, but retail sales surging and manufacturing recovering now point to a stronger US real economy
Inflation: the consumer price index (CPI) eased from 6.5% to 6.4%, above expectations, with the core CPI ex food and energy also from 5.7% to 5.6%. The details show that energy and goods are still falling in price, but services inflation has yet to peak, let alone fall, representing 4.1% of the total 6.5% headline reading.
The producer price index (PPI) fell, but not as much as expected after a strong month in January and the previous data were revised up. As a result, PPI final demand fell from 6.2% to 6.0%, with the PPI ex food and energy from 5.5% to 5.4% and the PPI ex food, energy and trade from 4.6% to 4.5%.The PPI in services, and in particular medical services, were very strong.
The import price index fell -0.2% in January after a -0.1% prior month with the index ex petroleum up 0.2% and the export price index up 0.8%.Year-on-year, the import price index rose 0.8% and the export price index 2.3%, both down significantly from the previous reading.
Consumer: US retail sales rose in January by the most in nearly two years. The value of overall retail purchases increased 3% in a broad advance after a -1.1% drop in the prior month. Excluding gasoline and autos, retail sales rose 2.6%, also the biggest increase in nearly two years. All retail sectors rose, led by motor vehicles, furniture and restaurants, with vehicle sales climbing 5.9%.
Surveys: the National Federation of Independent Business (NFIB) Small Business optimism Index bounced back from 89.8 to 90.3, below expectations and still way below the post-COVID-19 high of 104. Despite the higher headline, the details are less positive, showing that only 7% of companies are interested in expanding their business now; 21% expect to invest further and 22% of companies expect to increase compensation.
The Empire Manufacturing Survey (NY State) rebounded sharply from -32.9 to -5.8. The New York Fed Services Business Activity Index improved from -21.4 to -12.8. The Philadelphia Fed Business Outlook Survey, however, slumped from -8.9 to -24.3. The Leading Index (also known as Index of Leading Economic Indicators) fell -0.3% in January, following -0.8% the previous month, the tenth monthly decline.
Housing: the Mortgage Bankers Association (MBA) Mortgage Applications Series fell -7.7%, from +7.4% the previous week. The National Association of Home Builders (NAHB) Housing Market Index recovered from 35 to 42. Housing starts dropped -4.5% in January, from -3.4% previously and building permits were almost flat, +0.1% from -1.0%.
Industry: manufacturing production in January was up 1.0% from a negative -1.8% the prior month. Capacity utilisation was slightly lower at 78.3% vs. 78.4%. Business inventories in December rose 0.3%, unchanged from before.
Employment: the jobless claims series remained at a level close to historical lows, with initial claims at 194K vs. 195K and continuing claims rising from 1680K to 1696K.
United Kingdom
Inflation lower and retail sales stronger than expected, but employment still tight
Employment: employment was still very solid, with the January payrolled employees monthly change surging to 102K from an upward revised 47K and the claimant count rate remaining at 3.9%. The jobless claims change was negative at -12.9K, i.e. jobless claims were decreasing. The December International Labour Organisation (ILO) unemployment rate was steady at 3.7%, with the 3 months to 3 months employment change rising by 74K vs. 27K previously.
Inflation: average weekly earnings for the last 3 months year-on-year eased to 5.9% from 6.5%. Inflation fell, with the CPI down to 10.1% in January from 10.5%, below estimates, with core inflation down sharply to 5.8% from 6.3%, driven by transportation prices with fuel and airfares decreasing sharply. The PPI also fell, from 14.6% to 13.5% for the PPI output and from 16.2% to 14.1% for the PPI input.
Housing: the house price index decreased from 10.6% to 9.8% year-on-year in December.
Consumer: positive retail sales surprised, rising 0.5% in January including auto fuel, and 0.4% excluding auto fuel, although the year-on-year growth is still at -5.1% and 5.3%, respectively.
Europe
A somewhat better inflation picture
Industry: eurozone industrial production fell -1.1% in December from a positive 1.4% the prior month.
Inflation: the German wholesale price index fell from 12.8% to 10.6% year-on-year in January. The German PPI eased from 21.6% to 17.8%. The French CPI, however, remained sticky at 6.0%, or 7.0% EU harmonised.
China/India/Japan/Asia
Limited data for the week
China: new home prices were flat in January, after -0.25% the previous month.
Japan: the tertiary industry index (i.e. services) fell -0.4% in December, from +0.1% the prior month. Capacity utilisation also fell -1.1%, after -1.4%.
Core machine orders rose 1.6% in December after a huge -8.3% drop the previous month.
Oil/Commodities/Emerging Markets
Commodity prices generally hurt by the stronger US dollar
Oil prices took a tumble, whether in the US or globally, partly due to higher inventories but also renewed doubts about Chinese growth after the balloon incident.
Gold was also weak, partly due to the recovering dollar but also because of higher interest rates across the board.
Copper and iron ore were strongly bid, but other industrial metals (nickel, aluminium) were much softer.
