Markets last week
Last week we saw the beginning of a change within financial markets regarding the rate rises and potential rate cuts that the US Federal Reserve (Fed) is likely to implement. This movement was triggered mostly by the minutes of the July Fed meeting. Reading the commentary carefully, investors realised that the Fed is willing to run the risk of a recession in order to beat inflation. Overall, markets are now assuming that there is less than a 50% probability of a 50 bp hike at the September Fed meeting but are also starting to show less confidence that the Fed will cut rates early next year, with the equivalent of 50 bps of forecast hikes being removed from the market expectations for 2023.
Concerns about China resurfaced. Providing further evidence for slowdown, China’s apparent oil demand last month was about 10% lower year-on-year. Due to the scarcity of Chinese statistics, predictions of a downturn are difficult to verify, but foreign direct investment into China remained extremely healthy in recent data.
Economic data were once again confusingly mixed, but a few conclusions can be derived: in general surveys are falling across the globe; the US housing market has clearly peaked and is now in descent; employment is still in rude health everywhere making the central banks’ inflation fight much trickier; and Europe is the most depressed region with Japan surprisingly the most resilient.
Against that backdrop, the first noticeable move was the sharp rise in government bond yields, with gilt yields soaring 30 bps, German yields 24 bps and US yields rising 14 bps only. Interestingly, the yield curve (difference between short- and long-term yields) did not rise across the board but only longer bond yields went up, shrinking the two to 10-year difference from 40 bps to 26 bps.
Despite gilt yields rising faster than US treasury yields, the US dollar returned to its super-currency status during the week, with its index vs. developed currencies rising 2.4%.
Shares were mixed, with the US, Japan and emerging markets rising and Europe and the FTSE 250 falling. The best sectors were energy and defensives (consumer staples, real estate) and the worst financials and technology. Among equity investors, there is now an incipient realisation that the lack of immediate Fed rate cuts is going to affect the valuation of certain stocks and sectors in particular. So-called ‘profitless tech’ therefore corrected last week but is still top of the league of quarterly returns.
Commodity prices fell. The Chinese growth scare, added to the possible Iran nuclear deal, weighed on crude prices. This expected slowdown was less visible in copper and other commodities, but gold corrected sharply, partly due to the increase in the value of the US dollar.
The week ahead
Tuesday: manufacturing and services PMI for the UK, eurozone, Japan and US
Our thoughts: a global slowdown is probably underway, but this is waiting to be confirmed by data. The earliest statistics to forecast substantial growth changes are the PMIs and we will have the chance this week to see which countries are slowing down the most, with the betting odds on Europe, and potentially the US being the most resilient. The difference between manufacturing and services will also matter.
Friday: US PCE deflator and core deflator
Our thoughts: again, inflation will be the focus, with the PCE (personal consumption expenditures) in the US under scrutiny. Although less famous than its counterpart the CPI (consumer price index), the core PCE nevertheless has the honour of being the inflation gauge followed by the Fed. The last numbers were not so horrible by world standards, with the headline PCE at 6.8% and the core PCE at 4.8%. In light of the CPI falling last month, markets will be wondering whether the trend can be confirmed by the PCE.
Thursday-Saturday: Jackson Hole Fed Symposium
Our thoughts: once a year, the Fed stages a retreat in the ski resort of Jackson Hole, Wyoming, to which not only are Fed members invited but also central bankers from all over the world. It is not unusual to see the Governor of the Bank of England and the President of the European Central Bank attend the gathering among others. Its purpose is to explore the future of monetary policy rather than focus on the immediate task at hand and the outcome is always a defining speech by the Fed Chair, currently Jerome Powell. Such speeches have the power to move markets if they usher in new thoughts or a potential swerving of the policy direction. Last year, Mr Powell said that reducing the Fed’s balance sheet would not necessarily mean raising interest rates, which was obviously overtaken by events. Any new message from him this year would move markets.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed meeting minutes move market thinking towards more hikes and less leeway to cut next year
The minutes for the 26-27 July meeting of the Fed confirmed future rate hikes but with a caveat: “As the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases”. The Fed saw the risk of over-tightening policy but also of entrenched inflation: “In view of the constantly changing nature of the economic environment and the existence of long and variable lags in monetary policy’s effect on the economy, there was also a risk that the committee could tighten the stance of policy by more than necessary to restore price stability.” The implication is that the Fed might be willing to accept a recession as the price to pay to cut inflation.
Federal Reserve of San Francisco President Mary Daly said the Fed should raise rates “a little” above 3% by year end but cautioned against expecting rate cuts afterwards. Federal Reserve Bank of Richmond President Thomas Barkin said the Fed was determined to curb inflation. “We’re committed to returning inflation to our 2% target and we’ll do what it takes to get there. There’s a path to getting inflation under control but a recession could happen in the process.”
There were no comments from members of the MPC (Monetary Policy Committee of the Bank of England) following the publication of a double-digit consumer inflation number for the UK.
The People’s Bank of China cut interest rates, with the one-year loan prime rate from 3.70% to 3.65% and the five-year loan prime rate from 4.45% to 4.30%.
There is no doubt now that the housing market is falling, but economic surveys are showing a mixed picture
Surveys: there was a dreadful Empire State manufacturing survey down to -31.3 from +11.1, contrasting with a better Philly Fed (Philadelphia Fed Business Outlook survey), which rallied from -12.3 to +6.2. The Leading Index fell 0.4% in July, slightly better than the -0.7% of the prior month.
Housing: a gauge of US homebuilder sentiment declined for the eighth straight month, marking it the worst stretch since the 2007 housing market collapse. The National Association of Home Buyers/Wells Fargo gauge fell from 55 to 49, below the breakeven measure of 50 for the first time since May 2020. US housing is now featuring significant drops in housing starts (-9.6% in July), building permits (-1.3%), existing home sales (-5.9%). MBA mortgage applications fell 2.3%, down from +0.2% the previous week.
Consumer: retail sales were flat in July, but the control group was up 1.4%.
Employment: initial jobless claims stopped their upward trend for a week, easing to 250K vs. 252K, although the continuing claims rose from 1430K to 1437K.
Industry: business inventories rose 1.4% in June, down from 1.6% previously. Capacity utilisation increased from 79.9% to 80.3% in July. Industrial production rose 0.6% from a flat previous month.
Soaring inflation and a tight jobs market are weighing on confidence
Employment: employment was better in July, rising 73K with previous month revised up from 31K to 48K, 3.9% claimant count rate unchanged. In June average weekly earnings over the 3 months (annualised) fell from 6.4% to 5.1%, higher than estimates and the ILO unemployment rate was unchanged at 3.8%.
Inflation: inflation increased in July to double-digit levels. The CPI (consumer price index) rose from 9.4% to 10.1%, with the core CPI (ex food and energy) also rising from 5.8% to 6.2%. The PPI (producer price index) was mixed, with the PPI input (raw or intermediate inputs into the production process) down from 24.1% to 22.6% but the PPI output (factory gate prices) up from 16.4% to 17.1%.
Housing: the house price index dropped from 12.8% year-on-year to 7.8% in June.
Surveys: the GfK consumer confidence index fell to its lowest level since 1974, from -41 to -44.
Consumer: retail sales in July up 0.3% including auto fuel and up 0.4% excluding auto fuel, better than expected.
Public Finances: the Public Sector Net Borrowing Requirement fell in July from £20.1bn to £4.2bn.
Dismal surveys add to producer prices woes
Surveys: the ZEW survey was worse in the eurozone and Germany. The eurozone survey expectations fell from -51.1 to -54.9. In Germany, the expectations also fell from -53.8 to -55.3 and the current situation from -45.8 to -47.6.
Construction sector: the eurozone construction output fell 1.3% in June from -0.3% previously.
Growth: Q2 GDP growth was 0.6%, unchanged from the last quarter, with employment rising 0.3% during the quarter.
Inflation: the eurozone CPI (consumer price index) for July was revised up from 8.6% to 8.9%, with the core CPI remaining at 4.0%. The German PPI (producer price index) soared again from 32.7% to 37.2%, highlighting energy cost pressures on German industry.
Japanese data don’t signal any slowdown and investment into China is still strong
China: FDI (foreign direct investment) was almost unchanged at 17.3% year-on-year, vs. 17.4%.
Japan: exports rose 19.0% year-on-year in July, slightly below the previous month at 19.3%, whereas imports increased 47.2%, up from 46.1%. Core machine orders bounced back, up 0.9% in June vs. -5.6% the previous month. Capacity utilisation rose 9.6% in June, from -9.2%. The tertiary industry index (i.e., services) fell 0.2% in June, from +1.1% the previous month. The national CPI (consumer price index) rose from 2.4% to 2.6% with the core CPI ex fresh food and energy also up from 1.0% to 1.2%.
Oil prices have been impacted by the possibility that Iran may re-join the nuclear agreement with the US and hence would start exporting to western countries again. This has generally weighed on crude, whereas copper prices have been more buoyant, recovering above the US$8,000 level/metric tonne. Gold fell sharply during the week, down 3% in US dollar terms, but the dollar rose 2.4% against other developed currencies.