The numbers for the week – 20 Jun 2022
Markets last week
Last week was easily the worst for quoted assets in the volatile markets we have seen this year. It is fair to say that no investment was spared: equities, bonds, commodities. Even the almighty energy sector which has been providing the only positive equity returns this year, was completely trashed, slumping 15% during the week. The indiscriminate selling was probably a consequence of the policy announcement blitz by all the major central banks.
After allegedly leaking its intentions to US newspapers, the Federal Reserve Bank (Fed) raised rates by 75 bps, the biggest increase since 1994. The European Central Bank (ECB) had an emergency meeting barely one week after its official meeting, to deal with the turmoil in peripheral eurozone government bonds, as Italian and Greek bonds were collapsing compared to core eurozone bonds (Germany, etc.). We also saw rate hikes from the Bank of England (25 bps) and the Swiss National Bank (50 bps). Only the Bank of Japan stood as a beacon of tranquillity by not even talking about any future policy changes, although it had to deal with speculators shorting the Japanese Government Bond market (JGB). It looks unlikely that the global bear market in government bonds will end without JGBs being taken into the selling spree.
Market commentators lifted their probability of a US recession. It is hard to find anyone now mentioning less than a 50% chance of a slump. Indeed, the widely followed Atlanta Fed GDPNow forecast fell to near 0% growth for the current quarter. Technically, after a negative Q1, another falling quarter would be labelled a recession.
In light of such heightened expectations, US data have been watched very carefully. The housing market seems to be falling broadly now, with the hitherto defensive housing starts and building permits finally succumbing to the overall sector slowdown. Jobless claims now seem to be on an upward trend, albeit still at a subdued level by historical standards. Some surveys are starting to approach all-time lows.
Over the week, bond yields once again rose, but the sharpest increases were in European bonds, with US treasuries and UK gilts only picking up 7 bps and 5 bps, respectively. Commodities collapsed across the board, but energy was the most noteworthy. Despite no improvement in the Ukraine war or broader supply issues, Brent crude fell 7% and the US WTI gauge 9%. Oil had been the most resilient commodity amid a sector which was already correcting, with copper prices now down 15% from their peak. The US dollar resumed its upward trend as gold fell only marginally.
In equities, the bond and commodity movements impacted all sectors and countries. Japan and the US fell the most and Hong Kong the least, but the differences were not meaningful. Interestingly, at the sector level, the weak technology/strong energy pairing we have seen almost all year, was reversed. Even boring utilities dropped 8% on the week.
If there was a silver lining to the turmoil, it is that the markets now agree with the Fed on expected interest rate hikes this year, with the Fed’s “dot plots” (forecasts by Fed members about future rates) in line with bond market estimates. This seems to indicate that the relentless upward surprise on rates from the Fed, may well be in line with market pricing now.
The week ahead
Wednesday: UK inflation (CPI, RPI, PPI)
Our thoughts: with the Bank of England mentioning a possible peak in inflation at 11% (!), markets will ask themselves how soon we can get there and start falling from that level. Whereas the second question is more elusive, the first one may well be sorted out in the next few months. The CPI (consumer price index) is the most visible gauge and is expected to have a slight uplift from last month. Underneath the surface, though, the PPI (producer price index) is showing further inflationary pressures to come, with the PPI input (factory prices) and the PPI output (manufactured products for domestic market) liable to feed into consumer prices later on. More increases there would be negative for the overall inflation picture.
Thursday: manufacturing and services PMIs in UK, eurozone, US (Thursday) and Japan (Wednesday)
Our thoughts: with the Fed determined to slow down the US economy and other central banks generally following suit at a distance, watching the downturn through the PMIs could be an exercise the markets are willing to undertake. The UK and Europe are expected to show a mild drop in June from the May levels for both manufacturing and services, the US looks a little more resilient at this stage in the cycle and Japan may well buck the trend, going up rather than down, thanks to an incipient recovery in neighbouring China. Only major surprises are liable to move the markets.
Friday: UK retail sales
Our thoughts: retail sales, with or without auto fuel, have not been cheerful in the UK for close to a full year now. It seems as though the British consumer has been prescient in anticipating the terrible inflationary conditions and started reducing spending some time ago. Will the trend change or are we in a downward spiral? The estimates are quite negative for May data. The details matter as well. Which areas of spending are people cutting? Is it only the essential necessities that are left unscathed?
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
All the major central banks on show, but the Fed moves markets the most
The US Federal Reserve (Fed) announced its biggest rate increase since 1994, by 0.75%. Fed Chair Jay Powell said that the July meeting could see another 50-75bp hike but added that 75bp rate increases are atypically large and unlikely to become the new norm. There was one dissenting vote from Esther George, governor of the Kansas City Fed, who is generally known as a hawk but who just wanted a 50bp hike.
Chair Powell said the Fed was not out to drive the economy into recession, but effectively admitted it could happen, though he argued it was due to factors beyond their control (geopolitics, supply-chain issues). Powell said that several months of compelling evidence of falling inflation are required before believing “job done”. The commentary added the sentence: “the Committee is strongly committed to returning inflation to its 2% objective”, which reinforces the high hurdle before the all-clear.
All Fed officials expect the Fed Funds rate to increase to at least 3% by the end of this year, with the median estimate rising to 3.4%. The median rate forecast rises further to 3.8% in 2023.
The Fed’s economic projections show GDP at 1.7% this year, down from 2.8% at their March meeting. They also revised their PCE (Personal Consumption Expenditures) inflation rate up from 4.3% to 5.2%. The unemployment rate is forecast to rise to 4.1% in 2024, which would be consistent with a mild recession.
The European Central Bank (ECB) had an emergency meeting, in which it confirmed its flexibility in reinvesting redemptions coming due in the quantitative easing (QE) portfolio and will create a new anti-fragmentation instrument. This helped beleaguered Italian and peripheral eurozone bonds, compared to German bonds.
The Bank of England (BoE) hiked by only 25 bps to 1.25%, overshadowed on the same day by the normally conservative Swiss National Bank (SNB) which hiked 50 bps from -75 bps to -25 bps. More importantly, the BoE did not give us any forward guidance on future rate changes, unlike the Fed and even the ECB.
The Bank of Japan (BoJ) kept its policy balance rate at -0.1% and its 10-year yield target rate at 0%, which effectively means below 0.25% for the 10-year Japanese Government Bond.
The People’s Bank of China (PBoC) left its one-year medium-term lending facility rate unchanged at 2.85%, as well as the 1-year loan prime rate at 3.70% and the 5-year loan prime rate at 4.45%.
Sticky inflation, clearly slowing housing market, unemployment starting to pick up and downbeat surveys, all adding up to an incipient slowdown
Inflation: the PPI (producer price index) reaccelerated in May, rising 0.8% with core prices up 0.5%. In annual terms, headline PPI inflation moderated slightly by 0.2% to 10.8% year-on-year, fuelled by goods prices that are up 16.6% while services have risen a relatively softer 7.6%. The core PPI also moderated slightly, easing 0.1% to 6.8%. The PPIs for energy and food remain very high at 45.3% and 13.0%, respectively.
Headline US import prices rose 0.6% in May after an upwardly revised 0.4% in April, while core non-fuel import prices declined 0.3% following April’s 0.4% advance. Annual import price inflation moderated by 0.8% to 11.7%.
Surveys: small businesses were downbeat with the NFIB’s Small Business Optimism index falling 0.1 to 93.1 in May, the lowest level since April 2020. A record net negative 54% of businesses expect the economy to improve in the next six months. More than half of small businesses said they were unable to fill job openings, a 48-year record. and 92% of the businesses hiring reported few or no qualified applicants for their open positions.
The Empire State (NY) Manufacturing index recovered from a very low -11.5 to -1.2 in June. The Philadelphia Fed Business Outlook survey fell from +2.6 to -3.3, way below consensus. Cost pressures stayed high, unfilled orders fell and inventory growth was significant.
The Leading Index was down -0.4% in May, from -0.3% the previous month.
Housing: the NAHB Housing Market Index fell for a sixth straight month in June, declining two points to 67. Mortgage applications rose 6.6% last week, probably to secure a mortgage before rates move higher still, as the 30-year loan increased to 5.86%, the highest since November 2008.
Housing starts were down 14.4% in May and building permits down 7%.
Industry: inventory growth moderated to 1.2% in April. Industrial production rose 0.2% in May, down from 1.4% previously, with manufacturing production down -0.1%. Capacity utilisation was a little higher at 79.0% vs. 78.9%.
Retail: retail sales declined 0.3% last month but the volume of sales fell 1.6% after a 1.3% gain in goods prices. The control group for retail sales unexpectedly fell to 0.5% from 1.0% previously.
Employment: initial jobless claims stood at 229K, roughly the same as the previous week at 232K with continuing claims starting to edge up from 1309K to 1312K.
Is the jobs market starting to turn?
Employment: the jobless claims change in May reduced from -65.5K to -19.7K, whereas the April ILO unemployment rate rose from 3.7% to 3.8%. Employment change three months/three months increased to 177K in April. Average weekly earnings three months/three months were slightly more subdued, at 6.8% vs. 7.0%.
Housing: Rightmove house prices in June rose 0.3% for a year-on-year softer growth of 9.7% vs. 10.2% the prior month.
Some signs of stabilisation in economic activity
Surveys: the German ZEW index improved slightly in June from the Ukraine lows, in line with the eurozone Sentix Investor Confidence earlier in the month. The current conditions subindex increased by 8.9 to -27.6. The expectations component increased as well (up 6.3 to -28.0). The expectations for the eurozone ZEW survey improved less, from -29.5 to -28.0.
Industry: eurozone industrial production grew by 0.4% in April after falling by an upward-revised 1.4% in March, driven by energy production. The EU27 new car registrations series was down -11.2% in May year-on-year, better than the previous -20.6%.
Green shoots in China?
China: industrial production was positive 0.7% in May following a big drop in April. Retail sales fell -6.7% year-on-year, up from -11.1% the previous month. Investment (known as fixed assets ex rural) was almost unchanged, up 6.2% vs. 6.8%, but property investment was down 4% from -2.7% previously. The jobless rate improved to 5.9% from 6.1%.
Japan: capacity utilisation was flat in April after a previous drop. Core machine orders rose a strong 10.8% in April for a 19% year-on-year growth, up from 7.6% the prior month. The tertiary industry index (i.e. services) was up 0.7% in April, from 1.7% before. In May, imports rose a massive 48.9% year-on-year, up from 28.3%, whereas exports rose 15.8%, up from 12.5%.
Oil finally responding to gravity
Petroleum price volatility was enormous last week, with the Brent crude gauge topping US$125/bbl before finishing the week at US$113. Large drops in energy prices don’t seem to be driven by any fundamental change in supply but by the fear of a global slowdown and in particular a US recession.
Metal prices have also been weak for a few months now, with copper down 15% from its March peak. Gold, however, seems to be more resilient and fell only 1.7% in US dollars.