Markets last week

A spanner in the works of the financial markets was thrown by the US Federal Reserve (Fed) last week. Whereas the comments made by Fed Chair Powell did not indicate any major change in policy direction, the expected future rate levels provided by Fed members (“dot plots”) rose sharply for 2023, surprising bond and equity markets.  Fed member James Bullard added to market woes on Friday by suggesting that the first Fed hike could be next year, as there could be some upside risk to the inflation forecast.

At the beginning of the week, industrial shares were buoyed by the announcement of a resolution to the US-EU Boeing-Airbus trade dispute, lifting the threat of tariffs. Despite many statements and smiles, G7 announcements did not have much impact on the investing world.

Leading Economic Indicators (LEIs) across the world are generally positive but now show a mixed picture: the UK is below 100, at 99.6; Japan and the US both at 100.6; Germany at 101.6 and China at 102.5. LEIs tend to correlate with real GDP. During the week, economic data were mixed in most parts of the world, with the exception of China, which is still showing the fastest growth among large economies.

Markets reacted sharply to the Fed dot plots, with bond yields soaring, equities falling and a strong bid for the US dollar. At the end of the week, the rise in yields was partly unwound, but the equity and currency movements remained. Over the week, equities generally fell with UK shares faring worst and emerging markets being the most resilient. The slump in Asian markets this morning is pointing to a deeper move down in risk investments.

UK gilt yields are still 5 bps higher than at their bottom in February, but sterling has not benefited from the higher yields, given the heightened expectations for US Fed action on rates in 2023. The US dollar is up more than 2% over the last 4 weeks. Industrial metals are foreshadowing a softer manufacturing backdrop, with copper falling quite sharply from its peak above US$10,000/metric tonne. 

The week ahead

Thursday: Bank of England meeting

Our thoughts: with the US Federal Reserve (Fed) making waves in the markets with a movement in expected interest rates, the focus is shifting to other central banks that might change their guidance, too. The Bank of England is particularly visible in that respect. UK inflation has historically been volatile and hit very high levels in the last cycle. The Bank of England could well hike rates around the same time as the Fed and conceivably even ahead of the Fed. Some members of the MPC (Monetary Policy Committee) have been vocal in expressing concerns about rising inflation whereas Fed members are mostly sticking to a view that price rises are transitory. The reopening of the UK economy has the potential to cause bottlenecks and supply chain issues of a greater nature than in other developed countries, due to the recent Brexit trade arrangements. The lifting of the furlough scheme may well complicate the inflation picture, but markets will be looking for guidance from the BoE voting and comments from individual members afterwards.

Thursday: US jobless claims

Our thoughts: the market was expecting an uncomplicated fall in jobless claims last week, drawing a nice picture of steady drops in claims week after week, supporting growth and boosting inflation. Last week’s unexpected rise thwarted the expected scenario that companies are finding it difficult to recruit for new positions due to skills mismatches and lack of willingness to take new jobs, leading to fewer redundancies and hence a significant taper in jobless claims. Will we go back to this trend this week or are claims stuck at a higher level? Markets will probably react to any surprise here.

Friday: US PCE deflator and PCE core deflator

Our thoughts: once again, inflation numbers will be under scrutiny, but this time it is the core PCE (Personal Consumption Expenditures), the gauge followed by the Fed. The Fed is forecasting core PCE inflation at 3.0% for Q4 2021, slowing to 2.1% in 2022. The current expectation is for 3.5% for May. So far, nearly all inflation estimates have been beaten globally. An outsize core CPE on Friday could confirm market fears of higher inflation that the Fed would have to react to. Worth the wait!

The numbers for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Fed spooks markets with increase in the dots for 2023

In an eagerly expected meeting, the US Federal Reserve (Fed) left interest rates and the pace of QE (quantitative easing – i.e. asset purchases) unchanged, as expected. It will continue to purchase US$120bn per month in securities (including US$80bn of Treasury securities) “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”

While the recovery is not complete, many Fed members appear more confident that the US economy is progressing toward their goals.  Fed Chair Jay Powell said that a discussion on tapering QE purchases was possible soon but noted that the US is still not at the “substantial further progress” standard that would allow the Fed to raise interest rates.

The Fed dots (forecasts for future Fed Funds rate) rose from the zero bound in 2023, but Powell noted that there is a large amount of uncertainty in the next two years. Now 13 Fed members are expecting the first rate hikes in 2023, up from seven in March, with the median 2023 projection for two hikes. Still a majority of 11 participants are expecting no change next year. The market reacted strongly to the increase in the dots but may well be under the mistaken impression that the dot plots add up to Fed policy. As we saw in the last cycle, there is often a chasm between the dot forecasts and future changes in policy.

On inflation, despite expecting a stronger labour market, the Fed reiterated that US inflation will be transitory, as a limited number of products and services are responsible for most of the inflation increase. Nevertheless, the Fed’s inflation forecasts show an increase for Q4 2021 core PCE (personal consumption expenditures) to 3.0%, from 2.2% in March, returning to a lower level of 2.1% in 2022.

United States

US inflation data still scary but markets less affected than last month

Inflation: inflation expectations rose to an eight-year high in May, according to a NY Fed survey. Consumers anticipated an inflation rate of 3.6% over three years, up from 3.1% in April, with one-year expected inflation up to 4% in May, a rise from 3.4%. Significant cost pressures were anticipated in food, rent, petrol, healthcare and education. This survey, of course, clashes with the recent University of Michigan survey and the inflation breakevens, which have all been coming down.

The PPI (producer price index) rose 0.8% in May or 6.6% year-on-year. The core PPI rose 0.7% or 5.3% year-on-year. Despite these numbers being records, we note that the series was revamped in 2010. PPI also does not track well with CPI, though (in China we just had 9% PPI and 1.3% CPI).

Employment: initial jobless claims rose to 412K from 375K, a upside surprise but the week after Memorial Day may create some statistical quirks. Continuing claims were almost unchanged at 3518K.

Sales and Production: total retail sales fell 1.3% in May, below expectations. Sales ex-autos fell 0.7%. Despite the disappointment, retail sales are up 22% over 2019! Again, another good reason why 2021/2020 statistics don’t make much sense these days and we should focus on 2021/2022 where possible. Industrial production rose 0.8% in May, lifted by a rebound in mining extraction, up 1.1%, while manufacturing output rose a solid 0.8%.

Surveys: the June Empire State manufacturing index fell to 17.4 from 24.3. Manufacturing is doing well, but activity is no longer accelerating. The Philadelphia Fed Business Outlook survey eased slightly to 30.7 from 31.5. Orders fell sharply but prices, shipments and employment rose strongly. There were lower unfilled orders, which means that bottlenecks and supply restrictions are waning.

Housing: the housing market has turned softer in the last few months. The NAHB homebuilder index fell to a 10-month low of 81, from 83 in May. Housing starts rose 3.6% to 1,572K, below estimates. Building permits fell 3.0% to 1,681K.

United Kingdom

Some negative surprises on housing and retail sales, plus inflation rising but not as much as in the US

Employment: the labour force survey rose 113K in the three months to April compared to the previous three months. The three-month average unemployment rate fell to 4.7% in April, from 4.8% in March. The year-on-year growth in average weekly earnings, including bonuses, rose to 5.6% in April, from 4.3% in March. The May PAYE estimates show the number of payroll employees rising by 0.7%.  It is also doubtful that the furlough scheme can be wound up at the end of September without triggering a renewed decline in employment in Q4. Approximately 8% of the workforce is currently on furlough.

Inflation: the CPI (consumer price index) increased to 2.1% in May, from 1.5% in April and the core CPI inflation also rose to 2.0%, from 1.3%. Most of the increase was due to price hikes by reopening services businesses, but motor fuel, clothing and personal grooming services also experienced price surges, whereas food prices declined, due to base effects.

In addition, the PPI (producer price index) output rose to 4.6% and the PPI input to 10.7%.

Housing: the Official House Price index fell by 1.9% in April, with the year-on-year growth reducing to 8.9% from 9.9% the previous month, in part due to surges in purchases driven by the stamp duty extended allowance ahead of the expected expiry.

Sales: retail sales fell against expectations of a rise. Sales including auto fuel dropped 1.4% and 2.1% excluding auto fuel. The year-on-year is obviously very strong, 28.3%, but down from 42.4% the previous month. More interesting is the comparison with 2019, up 8.4%.

Health: the UK recorded the most COVID-19 cases in one day since mid-February, more than 11,000, despite more than 8 out of 10 people having had at least one jab.

Europe

Mixed picture on growth and inflation

Industry: eurozone industrial production rose by 0.8% in April, with the year-on-year rate jumping to 39.3%, from 11.5% in March.  Energy production increased the most, by 3.2%. Capital goods output rose too, by 1.4%.

Output in Eurozone construction fell by 2.2% in April, but the year-on-year was up to +42.3%. German construction was the biggest culprit behind the monthly fall.

Inflation: the CPI (consumer price index) in the Eurozone rose to 2.0% year-on-year in May, from 1.6% the previous month, with core CPI increasing by 0.3%, to 1.0%. Energy inflation was the main mover in the CPI at +13.1% year-on-year. German CPI rose to 2.5% in May (from 2.0%) and in France up to 1.4%.

Labour costs in the Eurozone rose by 1.5% year-over-year in Q1, slowing from a revised 2.8% rise in Q4, as more people are employed.

Trade: the trade surplus in the Eurozone plunged to €9.4bn in April, from €18.3bn in March, well below estimates. The current account surplus rose, however, to €22.8Bbn in April, from €17.0bn in March.

China/India/Japan/Asia

China still leading in world growth

China: the May data are not showing a major slowdown. Retail sales rose 25.7% year-on-year, down from 29.6% the previous month. Industrial production increased 17.8% down from 20.3%; non-rural investment 15.4% from 19.9%; property investment 18.3% from 21.6% and the surveyed jobless rate 5.0% vs. 5.1%. Given that this time last year the Chinese economy had already recovered, these numbers are very strong indeed.

Japan: industrial production had a good month in April, up 2.9% after 2.5% the previous month, with the year-on-year rate rising to 15.8%. Exports rose 49.6% year-on-year in May while imports were up 27.9%. Core machine orders in April rose 0.6% for a 6.5% year-on-year increase.  Lastly, the national CPI (consumer price index) fell 0.1% in May, with the core CPI ex fresh food and energy down 0.2%.

Oil/Commodities/Emerging Markets

The Fed meeting sent government bond yields higher and hence gold prices lower. Cyclical commodities parted directions, with oil still buoyant whereas copper and industrial metals are correcting. At the end of the week, gold fell 6% on higher interest rate expectations, Brent oil rose 1% and copper fell 8%.