The numbers for the week – 23 Jan 23
Markets last week
Risk markets had a change of mood after the roaring first fortnight of the new year. US equities were vulnerable as economic data weakened and officials at the US Federal Reserve (Fed) reiterated their uncompromising interest rate policy.
The general market consensus seems to be that inflation is no longer a problem, with headline CPI (consumer price index) numbers coming down in the US and the UK, as well as producer and wholesale prices in Europe. Japan bucked the trend, though, registering a 41-year high in CPI. The Bank of Japan (BoJ) seemed to be unperturbed by the general direction of prices, expecting inflation to come back down below 2% next year and not making any changes to its yield curve control policy, let alone its interest rates. The BoJ’s inactivity helped Japanese equities last week, although many market commentators pointed out that the central bank’s policy could well change when Governor Kuroda retires in April.
Economic data are starting to signal an inexorable slowdown in the US as well as in the UK, as the lagged effect of higher interest rates is being progressively felt. US surveys are still generally falling, but the real economy is now moving in that direction as well, with retail sales and industrial production drops in addition to the housing market woes. UK data were eerily similar in trend and, in both countries, employment is still very sticky. US jobless claims were close to an all-time low at a time when the Fed is hoping for companies to shed some jobs to help in its inflation fight.
Other parts of the world appear to be rebounding, however, with European statistics showing some incipient recovery and the Chinese economy poised for some revival, although it is too early to see the real impact of the very recent lockdown reopening.
Today’s Chinese Year of the Rabbit is ushering in cheerful expectations, and it is still clear that Chinese and Asian markets in general are leading the pack.
Lower inflation data and concerns about a US recession later this year have been driving government bond yields lower over the last week with some year-to-date drops of 40 bps in the US and Europe, although a little less in gilts. On Friday, most government bond markets corrected from a very strong run and yields jumped by some 10 bps across the board.
Commodities have continued their strong China-driven surge recently, as the US dollar is still the weakest developed currency this year which tends to support commodity prices.
A late Friday rally in US equities did not stop them being the worst performers last week, whereas China and emerging markets once again held up better than the rest of the world. The Friday move was driven by technology shares in the expectation that the large job cuts announced by some of the largest companies would boost their earnings. As a result, the best performing sector over the week was the technology complex and the worst performing were utilities, consumer staples and industrials. For the year-to-date, technology and materials are ahead with defensive sectors barely up (healthcare, utilities, consumer staples).
The week ahead
Monday – Tuesday: manufacturing and services PMIs for eurozone, UK, Japan and US
Our thoughts: is the world slowing down or only some countries? This is the question markets will ask themselves this week when the S&P Global PMIs (purchasing managers index) are announced. There has already been a significant drop in manufacturing PMIs in the US, the UK and Europe. Recently the ISM (Institute for Supply Management) showed a major drop in the US services PMI. Was that an outlier or the beginning of a trend? Also, have European surveys really bottomed and is Japan still relatively immune? How bad is the UK given the strikes? Markets are hoping that the PMIs will answer these questions.
Wednesday: IFO survey in Germany
Our thoughts: few things have moved more than sentiment in Germany in the last few months. From the depths of despair ahead of a winter with little natural gas either for heating or industry, to a recovery due to exporters benefiting from the China reopening, full gas storage tanks and a mild winter, it is obvious that things have changed very fast. Have they really, though, or is this purely a perception? The IFO (Institut für Wirtschaftsforschung) survey has three subsections: business climate, current assessment and expectations. It has fallen sharply from the peak in 2018 and from the post-pandemic high and a turnround, in particular in the expectations, would indicate a recovery ahead for Europe’s largest economy.
Friday: PCE inflation in the US
Our thoughts: once again, markets will be glued to inflation prints in the US, hoping that they will show a continuation of the falls we have seen since the peak in the readings last year. Rather than the more famous CPI, the Fed follows the core PCE (personal consumption expenditures), core meaning ex food and energy. It can be said that all inflation measurements matter when the numbers are still very high, but the Fed has a 2% target for core PCE irrespective of what other gauges do. The headline PCE is likely to keep falling due to lower energy costs and their impact on industrial goods, but will the core reading and especially the services part, follow or remain sticky?
The numbers for the week
Central banks/fiscal policy
BoJ sticks to policy despite higher inflation. Many Fed officials speak, some favouring a moderation in rate hikes, but all suggesting that high rates are here to stay
The BoJ kept its yield curve control programme, prompting a sharp slide in the yen, Japanese government bond yields and a surge in Japanese equities. The BoJ said it would continue large-scale bond buying and increase it if needed. The BoJ’s forecast for inflation increased for this year from 2.9% to 3.0% but was kept at 1.6% next year, with GDP projections downgraded for 2023, 2024 and 2025.
Some European Central Bank (ECB) officials anonymously hinted at slowing down the pace of hikes after the expected 50 bps in February. ECB President Christine Lagarde said inflation remains far too elevated, vowing that the ECB won’t let up in its efforts to return price growth to the target. “Inflation by all accounts, whichever way you look at it, is way too high. We shall stay the course until such time we have moved into restrictive territory for long enough so that we can return inflation to 2% in a timely manner.”
Fed officials were quite vocal last week. Dallas Fed President Lorie Logan and Philadelphia Fed President Patrick Harker both backed moderating the pace of rate hikes (Harker repeating it during the week), whereas St. Louis Fed President James Bullard and Cleveland Fed President Loretta Mester stressed the need to keep policy restrictive for longer.
Boston Fed President Susan Collins said she favours a more moderate pace of interest- rate increases. “Now that rates are in restrictive territory and we may, based on current indicators, be nearing the peak, I believe it is appropriate to have shifted from the initial expeditious pace of tightening to a slower pace. More measured rate adjustments in the current phase will better enable us to address the competing risks monetary policy now faces. I anticipate the need for further rate increases, likely to just above 5%, and then holding rates at that level for some time.”
Vice Chair Lael Brainard said: “Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2% on a sustained basis. It is likely that the full effect on demand, employment, and inflation of the cumulative tightening that is in the pipeline still lies ahead”.
New York Fed President John Williams said that officials have not completed their aggressive tightening campaign to reduce stubborn price pressures. “With inflation still high and indications of continued supply-demand imbalances, it is clear that monetary policy still has more work to do to bring inflation down to our 2% goal on a sustained basis.”
The People’s Bank of China (PBoC) kept its rates unchanged, with the 5-year loan prime rate at 4.30% and the 1-year loan prime rate at 3.65%.
The slowdown is broadening from housing and surveys to retail sales and industrial production, but the jobs market is still close to the tightest ever
Surveys: the Empire State Manufacturing survey (NY State) plunged to -32.9 in January from -11.2, way below estimates. This is the lowest number excluding the COVID-19 lows and is in line with 2008-2009 lows. The Philadelphia Fed Business Outlook (“Philly Fed”) improved from -13.7 to -8.9, although this is still the lowest level in the decade ex the pandemic. The New York Fed services business activity index fell from -17.6 to -21.4.
Housing: housing starts fell 1.4% in December after -1.8% the previous month, and building permits dropped 1.6% after a 10.6% collapse. Existing home sales fell 1.5% in December for a 17.8% drop over 2022, the biggest slump since 2008. The weekly Mortgage Bankers Association mortgage applications soared 27.9% after 1.2% the previous week. The NAHB (National Association of Home Builders) housing market index rose from 31 to 35, rebounding from the low ex-pandemic.
Employment: jobless claims were extremely low. The initial claims fell from 205K to 190K for the week, one of the lowest levels ever. Continuing claims rose slightly from 1630K to 1647K.
Sales: retail sales fell 1.1% in December after -1.0% previously, with the retail sales control group also down 0.7%.
Inflation: the PPI (producer price index) fell more than expected but not at the core level. The PPI final demand fell from 7.3% to 6.2%, with the PPI ex food and energy down from 6.2% to 5.5% and the PPI ex food, energy and trade down from 4.9% to 4.6%.
Industry: industrial production in December fell 0.7% down from -0.6% the prior month, with manufacturing production down 1.3%. Capacity utilisation also fell from 79.4% to 78.8%. Business inventories rose 0.4% in November, up from 0.2%.
Same picture as in the US: housing fall broadening to retail sales and credit with a tight employment market. Inflation not falling as fast as in other countries
Housing: UK house prices pulled back. The average cost of a home fell to £295,000 in November, down by £1,000 from the month before but £28,000 more than a year ago, as reported by the ONS (Office for National Statistics). House prices climbed by 10.3% year-on-year in November, slower than 12.4% in October.
The RICS (Royal Institute for Chartered Surveyors) house price balance fell sharply from -26% to -42%, a very low number by historical standards.
Inflation: the CPI was in line with estimates at 10.5%, down from 10.7%, with the core CPI slightly above expectations, unchanged at 6.3%.
Employment: December employment was a little worse in terms of claimant count (4.0% vs 3.9%) and payrolled employees monthly change (28K vs 70K). The November ILO (International Labour Organisation) unemployment rate stayed at 3.7% and average weekly earnings over the last three months were up from 6.2% to 6.4%.
Credit: UK banks are more hesitant about lending to households than at any point since the financial crisis more than a decade ago, the Bank of England said in its quarterly credit conditions survey. The survey tracks banks’ expectations on unsecured credit to households and the gauge fell to -50.2 in Q4 down from -17.2 in Q3.
Retail: retail sales fell 1% in December, down from -0.5% the previous month, the ninth straight month of negative sales, with 2022 ending as the worst year since records began in 1997 at -5.8% including auto fuel and -6.1% excluding auto fuel.
Improvements in surveys not reflected in economic activity yet
Surveys: investor sentiment in Germany and the eurozone jumped to the highest level in almost a year. The ZEW institute’s gauge of expectations in Germany rose to +16.9 in January from -23.3, with the survey now near its 10-year average. The eurozone ZEW expectations also surged from -23.6 to +16.7.
Inflation: German wholesale price index down from 14.9% to 12.8%. The German PPI also fell, but not as much as expected, from 28.2% to 21.6%.
Industry: EU27 new car registrations decreased from 16.3% to 12.8% in December. The construction output for November fell 0.8%, down from +1.0% the prior month.
Is the Chinese economy recovering? Japanese inflation at 41-year high
China: the December monthly data delivery was mixed vs the previous month. Industrial production fell from 2.2% year-on-year to 1.3%, fixed assets ex rural (i.e. investment) also fell from 5.3% to 5.1%, property investment was down 10% from
-9.8%, but retail sales recovered from -5.9% to -1.8% and the surveyed jobless rate eased from 5.7% to 5.5%. The less meaningful Q4 GDP fell from 3.9% to 2.9%.
Japan: Japanese machine tool orders rebounded, up 1% year-on-year vs -7.7% previously, a good gauge of global industrial activity. The more domestic core machine orders fell 8.3% in November from +5.4% the previous month. Capacity utilisation fell 1.4% in November from -2.2% the previous month. The tertiary industry index (i.e. services) fell 0.2% in November, from +0.5% the prior month. In December export growth fell from 20.0% to 11.5% year-on-year, whereas imports dropped from 30.3% to 20.6%.
The national CPI rose from 3.8% to 4.0%, the highest level since 1981, with the core CPI ex fresh food and energy at 3.0%, up from 2.8%.
Strong commodities across the board
There was a surprise build-up in US oil stocks, but it didn’t stop prices from being sustained, consolidating the higher levels since the reopening of the Chinese economy. Indeed, both the Brent and WTI crude gauges rose sharply. Industrial metals were also quite strong, with copper up 1.5% for a year-to-date double-digit return.
On Friday, gold reached its highest level since April (in US dollars) topping US$1,930/oz before stabilising at US$1,926.