Markets last week
The week was marked by watershed meetings of the three most important western central banks (US Federal Reserve – Fed, Bank of England – BoE, and European Central Bank – ECB) against the backdrop of exceptionally high inflation readings in many countries. The Fed announced the doubling of tapering speed for its asset purchases and set a clear path for interest rate hikes in 2022 and 2023 with a joint focus on inflation and unemployment. The BoE raised rates, the first major central bank to do so this cycle, from 0.10% to 0.25% and forecast a peaking of inflation at 6% in April 2022. The ECB will stop buying bonds under the emergency pandemic programme in March 2022 but did not make any further changes to its policy, whilst updating inflation forecasts upwards. Surprisingly, the People’s Bank of China went against the grain with a small cut to its one-year loan prime rate, but the impact of such a move was overshadowed by the hawkish tones of the other central banks.
The Fed pivot was a rallying sign for risk markets on Wednesday, although some of the so-called ‘taper tantrum’ followed afterwards. The BoE move on Thursday took markets by surprise, sending gilt yields sharply up and boosting sterling and UK banking shares. The ECB meeting on the same day triggered an increase in European bond yields, with peripheral country yields rising faster than core countries. Oil prices and gold rallied after the central bank meetings.
It is unlikely that the Fed will get more hawkish than this. If inflation remains sticky at high levels, then the three forecast hikes next year are a foregone conclusion; but if we start to see some ‘give’ on inflation readings into 2022, it could be less. There is nevertheless a further way for the Fed to be more hawkish, by running down its balance sheet, but Fed Chair Powell said they have discussed it and made no decisions yet.
The UK is going to act as the live testbed for omicron and the economy, given our head-start both on dealing with the variant and, unfortunately, on the number of cases. What will be watched carefully is the ability to sever infections from hospitalisations with the vaccine and booster programme. The US is way behind on omicron, so this is still an issue ahead.
At the end of the week, most of the Wednesday moves had been unwound by markets, with equities down across the board, led by the US and emerging markets (the UK being the most defensive). The unusual combination of energy and technology performed worst, whilst defensive sectors, like healthcare, consumer staples and utilities rose against declining indices. Government bond yields finished the week down, the US dollar was the strongest of the main currencies and gold eked out a gain, while oil was under pressure.
Over the weekend, the announcement that Senator Manchin was pulling his support from President Biden’s Build Back Better legislation sent a shockwave through markets, setting the stage for a poor beginning to this week.
The fortnight ahead
Tuesday 21 December: UK public finances
Our thoughts: the UK government has been on a borrowing spree during the pandemic and is recovering from it on a monthly basis. Before national insurance contributions are raised for taxpayers during the next fiscal year, understanding the scope of the deficit and its potential improvement will matter to markets, in particular for gilts and sterling. The public sector net borrowing requirement, latterly at £18bn, is down from a peak of £52bn at the height of the COVID-19 crisis and mid-20s levels throughout the second half of 2020 and 2021. How much further can it fall and will omicron spoil that improvement?
Thursday 23 December: US PCE deflator
Our thoughts: inflation is still surging across the globe and every additional piece of data is liable to move markets, with particular emphasis on the core PCE (Personal Consumption Expenditures) which is used by the US Federal Reserve (Fed) as its inflation gauge. The expectation is for a further rise in both the headline reading and the core PCE ex energy and food. As usual, the devil will be in the detail and it will be important to analyse the components of price rises to separate those that can mean-revert (reopening sectors) and those that may be suffering from contagion (such as wages and rents).
Thursday 30 December: CFLP (China Federation of Logistics and Purchasing) official manufacturing and non-manufacturing PMI
Our thoughts: the Chinese economy has definitely slowed down, but how much? Is it a moderate drift that can be fixed by fiscal and monetary policy? Manufacturing has been hit by supply chain issues and soaring energy costs, in line with other major industrial economies, like Germany. The manufacturing PMI has been hovering round 50, which is the threshold between expansion and contraction, for some time and doesn‘t seem to be getting out of the range. Services are better behaved but nevertheless have shown some signs of slowdown. The manufacturing PMI has the potential to impact the rest of the world and hence will be followed closely.
Markets for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Three central banks: Fed helping equities, BoE helping sterling and ECB not making waves, with China going against the flow
The US Federal Reserve (Fed) doubled its QE taper pace, so that it could be finished buying assets by March. The median projection (‘dot plot’) is now for three rate hikes in 2022 and a further three hikes in 2023. This would take the Fed funds rate to 1.5% which is close to 10-year yield now, although the dot plots have a poor predictive power on future Fed rate moves.
There’s one test left before any rate hikes, with the statement: “with inflation having exceeded 2% for some time, the Committee expects it will be appropriate to maintain this target range until labour market conditions have reached levels consistent with the Committee’s assessments of maximum employment.” Alternate measures of unemployment (U-6 under-employment rate) are also falling quickly, hence this may be more of a box tick than a real hindrance.
The return to higher US labour force participation is expected to take longer. Fed Chair Powell noted that employers are having difficulty finding workers. Powell noted that we are simply not heading back to the same economy as we had in February 2020. Many factors that could improve labour participation are related to COVID-19 and its consequences on health and work.
The Bank of England was the first major central bank to raise rates, unexpectedly lifting the borrowing costs from 0.1% to 0.25%, the first hike in three years. Officials led by Governor Andrew Bailey voted 8-1 for the increase, with Silvana Tenreyro dissenting in favour of no change. Policy makers said more ‘modest’ tightening is likely to be needed as inflation heads toward a peak, likely to be around 6% in April. Governor Bailey said that there were signs of inflation becoming more persistent. The BoE left the gilt purchase target (quantitative easing) amount unchanged at £875bn.
Separately in the UK, the eight largest lenders passed the Bank of England’s stress test, noting that they would weather a double-dip recession and a worsening of COVID-19 conditions. Failing loans would push the capital level to 10.5%, comfortably above the 7.6% BoE minimum.
The European Central Bank (ECB) left its rates unchanged, although it agreed to stop the emergency pandemic programme of bond purchases in March 2022. The European Central Bank’s forecast for inflation is calling for consumer prices to rise below their 2% target in both 2023 and 2024, after 3.2% in 2022.
The People’s Bank of China (PBoC) cut its 1-year loan prime rate from 3.85% to 3.80%, the first such cut since April 2020.
President Biden’s Build Back Better legislation has suffered a major blow, with West Virginia Senator Joe Manchin, the indispensable swing voter on the bill, refusing to back it, out of concerns about inflation.
Mixed surveys, weak retail sales and soaring producer prices
Inflation: the November PPI (producer price index) was up 9.6%, with goods up 14.9% and services 7.1%. This compares with 6.8% for the CPI (consumer price index). Import and export prices soared, with the import price rising 0.7% in November, up 11.7% year-on-year and the export price up 1% or 18.2% year-on-year.
Surveys: the small business survey from the NFIB (National Federation of Independent Business) rose from 98.2 to 98.4. In the commentary, 59% of these businesses are raising average selling prices and 54% planning to do so. The former is the highest since the 1970s, the latter the highest on record. Furthermore, a record 32% of small business owners are planning to raise worker compensation. The Empire State (NY) Manufacturing survey was surprisingly stronger than last month, at 31.9 vs. 30.9, against expectations of a fall. The Philadelphia Fed Business Outlook Index (‘Philly Fed’) disappointed, though, collapsing from 39.0 to 15.4. The Markit PMIs were a tad softer, with the manufacturing PMI down to 57.8 from 58.3 and the services PMI to 57.5 from 58.0. Lastly, the Kansas City Fed manufacturing activity index remained unchanged at 24.
Housing: mortgage applications were down 4% over the week. The NAHB housing market index edged up from 83 to 84. Housing starts surged 11.8% in November and building permits rose 3.6%.
Sales: retail sales disappointed, rising 0.3% on the month, down from 1.8% the previous month, with retail sales ex auto and gas up 0.2|% and the control group down -0.1%.
Employment: initial jobless claims totalled 206K, up 18K from the prior period, with continuing claims dropping from 2 million to 1.845 million, a fresh post-COVID-19 low.
Industry: industrial production rose 0.5% in November, down from 1.7% the previous month, whereas capacity utilisation edged up from 76.5% to 76.8%.
Strong employment and 5%+ inflation
Employment: the number of employees on payroll rose 257,278 in November, the most on record. The unemployment rate fell to 4.2% in the three months through October from 4.3% in the period through September. Vacancies rose to a record 1.22 million between September and November. Overall pay growth slowed in the three months through October to 4.9% from 5.9% in the quarter through September. Claims for benefits among the unemployed and those on very low pay fell by 49,800 in November. The redundancy rate through October remained below pre-pandemic levels. Just under 100,000 were made redundant, a quarter of the level at the height of the pandemic.
Inflation: the CPI (consumer price index) surged to 5.1%, up from 4.2% the previous month, the most since September 2011, boosted by clothing, auto fuel and second-hand cars. The core CPI, excluding food, energy, alcohol and tobacco, climbed to 4%, the highest since the series began in 1997. The PPI (producer price index) also soared, with the PPI input at 14.3% and the PPI output at 9.1%.
Housing: the house price index (average price for all dwellings from the Land Registry) in October fell from 12.3% year-on-year to 10.2%.
Sales: retail sales rose more than expected in November, up 1.4%, compared to the previous month’s 1.1%. Sales excluding auto fuel grew 1.1%. Black Friday discounts helped consumers back into shops, as online sales declined to the lowest percentage since March 2020.
Surveys: the Markit manufacturing PMI eased from 58.1 to 57.6, but the Markit/CIPS services PMI slumped from 58.5 to 53.2.
Germany worst within the eurozone
Industry: eurozone industrial production rose 1.1% in October from -0.2% the prior month. New vehicle sales fell 17% in November, the worst showing for the month since the series started in 1993. October construction output in the eurozone rose by 1.6%, up from 1.0% the previous month.
Inflation: the German wholesale price index rose further from 15.2% year-on-year to 16.6%.
Surveys: the Markit eurozone manufacturing PMI eased from 58.4 to 58.0 but the services PMI fell more sharply from 55.9 to 53.3, with Germany registering one of the biggest drops in the services gauge. The Bank of France confidence indices were fairly steady, at 110 vs. 113 for business confidence, 111 vs. 110 for manufacturing confidence and 21 vs. 19 for the production outlook indicator. The widely followed German IfO survey fell across the board, with business climate down from 96.6 to 94.7, expectations from 94.2 to 92.6 and the current assessment from 99.0 to 96.9.
A little softer in China
China: the monthly data release showed some moderation from last month. Retail sales were softer at 3.9% year-on-year vs. 4.9% previously. Industrial production was higher at 3.8% vs. 3.5%, fixed assets ex rural (i.e. investment) eased to 5.2% from 6.1% and property investment from 7.2% to 6.0%, whilst the surveyed jobless rate inched up from 4.9% to 5.0%. Foreign direct investment rose 15.9% year-on-year in November, down from 17.8%.
Japan: the tertiary industry index (i.e. services) improved from 0.5% to 1.5% in October. Capacity utilisation grew 6.2% in October compared to a 7.3% drop the previous month.
Oil markets are stronger than the US government
“Global oil markets have returned to surplus and face an even bigger oversupply early next year as the omicron variant impedes international travel,” said the International Energy Agency (IEA). Supplies are rebounding around the world, the IEA said, with global oil inventories swelling at a rate of 1.7 million barrels a day in the first few months of 2022. Also, the IEA lowered forecasts for global oil demand in the first quarter by 600,000 barrels a day.
Gold prices were well supported following the Fed’s meeting.