The numbers for the week – 23 Oct 23

The numbers for the week – 23 Oct 23

Markets last week

“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market; you can intimidate everybody”. These words from James Carville, President Clinton’s advisor, in 1994 characterise the market woes of the last couple of years. Last week was no exception.

Indeed, US Federal Reserve (Fed) Chair Jay Powell delivered a continuing hawkish message on interest rates, which had been widely anticipated by markets in the last couple of weeks. He referred to longer-term bond yields as a significant part of the monetary tightening led by the Fed.

We continue to see heightened volatility in bond markets. The US Treasury curve continued its recent trend, steepening aggressively throughout the week. At the end of June, the US 10-year treasury yield was 3.8%; a month ago it had risen to 4.3%; and by the end of last week, 4.9%. Short-end yields have barely moved over the same periods, resulting in the yield curve steepening and the spread between two- and 10-year yields rising from -1.06% at the end of June to -0.16% at the end of the week. This type of move is known as a ‘bear steepening’ (when the curve steepens with the long end rising rather than the short end falling).

The momentum of this move was reinforced during the week by strong US industrial production, retail sales and jobless claims numbers. The implication being that the resilience of the US economy may push the Fed to increase interest rates one more time, to ensure that the inflationary dragon has been well and truly slain. Fed Chair Jerome Powell has said on a number of occasions that his preference is to risk overtightening – killing inflation but instigating a recession – than not tightening enough and inflation resurging. The market is now pricing in a 30% probability of another hike in the next three months. The rise in bond yields represents considerable tightening of financial conditions. Last week the US 10-year treasury bond yield briefly touched 5%, a level not seen since 2007, and the 30-year bond yield reached a high not seen since 1998. In the UK, 30-year gilt yields have also climbed to 1998 levels. The bond market continues to intimidate.

Last week was fairly poor for equity markets: the FTSE All World Index finished the week down 2.5%. US equities fell 2.5% in sterling terms. The FTSE All Share was down 2.6%. Energy and consumer staples were the only resilient sectors, whereas technology, industrials and real estate dropped quite sharply. The Q3 earnings season is in full swing, especially for companies in the US Financials sector. These firms have generally exceeded consensus earning expectations, despite challenges faced by the Financials sector this year.

China’s third-quarter GDP exceeded expectations, coming in at 4.9% year-on-year, vs. market expectations of 4.5%. Investors will need to see more substantial growth to overcome the extremely low level of confidence in the Chinese economy. The Chinese property sector continues to pose a persistent economic burden.

Inflation data released during the week was mixed. UK inflation in September didn’t slow as much as anticipated, primarily due to rising oil prices countering the downward pressure from food costs. The Consumer Prices Index (CPI) showed a 6.7% year-on-year increase, consistent with the previous month, defying economists’ expectations of a drop to 6.6%. This development reinforces the argument for the Bank of England (BoE) to maintain its highest interest rates in 15 years. The UK’s inflation situation appears more challenging than that of its peer countries.

In the eurozone, inflation data announced for September last week showed that it is on a downward trajectory. Eurozone CPI came in at 4.3%, in line with expectations, and down substantially from the prior reading of 5.2% for August. Core inflation also came down significantly, falling from 5.3% to 4.5%. Services inflation fell from 5.5% to 4.7% These numbers will reinforce the Governing Council of the European Central Bank’s narrative that they have most likely finished hiking.

One of the few defensive assets in last week’s market was gold, which soared 2.5% and moved closer to US$2,000/oz, at US$1,981.

The week ahead

Earnings season continues and will be a key indicator on the state of the economy and the risk of a recession

Tuesday: UK unemployment data

Our thoughts: The recent UK unemployment data reveals a disquieting trend. The unemployment rate has been ticking up over the last year, rising from a low of 3.5% in August 2022 to 4.3% in August this year. Given this trend, the data on Tuesday will be an interesting read across into other parts of the UK economy.

Thursday: US GDP

Our thoughts: GDP growth projections have been revised upward to 5.4%, reflecting resilient consumer spending, especially after better-than-expected September retail sales, potentially prompting a more aggressive monetary policy approach by the Fed. Thursday’s data will be a key indicator of the extent to which the interest rate hikes are impacting the economy.

Thursday: European Central Bank (ECB) interest rate decision

Our thoughts: Thursday’s ECB meeting presents a potential shift in the ECB’s monetary policy, with speculation that the deposit rate may have peaked at 4%. Minutes from the September meeting indicate a growing consensus that the interest rate hiking cycle has ended, due to concerns about economic slowdown and inflation deceleration. Given the potential for economic stagnation, it’s probable that the ECB will maintain rates with a ‘wait and see’ policy.

The numbers for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Recent rise in bond yields represents significant further tightening of financial conditions, leading Fed Chair to suggest the bond market is doing the job for the central bank

The move higher in bond yields is an interesting development for the Fed, as it represents a significant tightening of financial conditions without the need to hike rates. If the Fed are confident that the rise in bonds yields is likely to be sustained, they may be more likely to skip further hikes, and keep rates higher for longer. However, if they have concerns about potential inflation risks, like conflict in the Middle East triggering a surge in oil prices, they might opt for an additional rate hike. Ultimately, while long-term yields can offset rate hikes to some extent, relying solely on them may be risky given various potential supply shocks, a resilient economy and the current heightened volatility and uncertainty in yields.

Fed officials were busy speaking last week before their blackout period ahead of the next meeting, with Fed Chair Jay Powell saying: “I think the evidence is not that policy is too tight right now” and “there may still be meaningful tightening in the pipeline”.

On Wednesday, the Bank of Japan (BoJ) unexpectedly conducted a bond-purchase operation, underscoring its commitment to curbing the rapid rise in its government bond yields. Despite this move, the benchmark 10-year yield remained largely unaffected, reaching a 10-year high of 0.815%. Japanese government bonds have been under pressure due to the sell-off in US Treasuries, and market participants have been testing the BoJ’s tolerance as the central bank approaches its monetary policy meeting at the end of the month.

The ECB’s interest rate decision comes this week, and in light of the minutes from their prior meeting, and the sharp fall in inflation last week, the Governing Council is unlikely to hike rates. The swap market is now implying a c. 10% probability of a further hike in the next three months (looking to the January meeting).

BoE Governor Andrew Bailey signalled that the BoE’s inflation fight still had further to run, mentioning that food price declines have “got quite a way to go yet”, despite the UK economy weakening.

The People’s Bank of China kept its prime rate unchanged, with the one-year loan prime rate at 3.45%, and the five-year loan prime rate at 4.20%.

United States

US economy still looks very strong according to retail sales, industrial production, and jobless claims, despite poor surveys and the housing market suffering from 8% mortgage rates

Surveys: the Conference Board leading index fell 0.7% in September, following -0.5% the prior month. The Empire Manufacturing (NY state) survey worsened, from +1.9 to -4.6. The Philadelphia Fed Business Outlook survey improved marginally from -13.5 to -9.0, below estimates. The New York Fed services business activity index slumped from -3.0 to -19.1.

Housing: the National Association of Home Builders housing market index dropped from 44 to 40. Housing starts were strong, up 7% in September after -12.5% the previous month, whereas building permits fell 4.4% after +6.8%. Existing home sales fell 2% in September, down 19% from one year ago and to the lowest level since 2010. Mortgage rates exceeded 8% ( average) for the first time this century, and Mortgage Bankers Association mortgage applications fell 6.9% the week ended 13 October.

Industry: industrial production rose 0.3% in September, of which manufacturing production was up 0.4%. Capacity utilisation increased further from 79.5% to 79.7%. 

Employment: initial jobless claims fell from 211K to 198K, the lowest level since January, with Texas, New York and California leading the decline, but continuing claims rose from 1705K to 1734K.

Consumer: retail sales were strong in September, rising 0.7%, following +0.8% the prior month, with sales ex auto up 0.6%, and the retail sales control group also up 0.6%.

United Kingdom

Still sticky inflation, low consumer sentiment and weak retail sales (although the weather had something to do with the latter)

Employment: the payrolled employees monthly change was negative, at -11K in September, after -8K the previous month.

Surveys: the GfK consumer sentiment index fell sharply, from -21 to -30, the largest drop since the first Covid lockdown in 2020.

Inflation: the CPI did not fall as much as expected, with the headline CPI staying at 6.7%, the core CPI down from 6.2% to 6.1% and the CPI services actually higher, at 6.9% vs. 6.8%. The producer price index (PPI) continued at a weak level, with PPI input down from -2.0% to -2.6%, and output higher, at -0.1% vs. -0.5%. Average weekly earnings for the last three months to August eased from 8.5% to 8.1%.

Housing: the house price index kept rising in August, up 0.2% after +0.7% the previous month.

Consumer: September retail sales fell 0.9% including auto fuel, and -1.0% ex auto fuel, driven by clothing sales down 1.6% due to warm weather.

Public Finances: the Public Sector Net Borrowing Requirement increased from £10.6bn to £13.5bn in September, albeit below estimates.


Slight recovery in survey expectations despite data looking weak

Surveys: the ZEW survey for the eurozone jumped from -8.9 to +2.3. The expectations component also increased in Germany, from -11.4 to -1.1, but the current situation was barely changed at -79.9 vs. -79.4. Confidence fell in France, with business confidence down from 100 to 98, manufacturing confidence from 99 to 98, the production outlook indicator from -6 to -10, own-company production outlook from +17 to +5 and the business survey overall demand from 0 to -2.

Industry: eurozone construction output dropped 1.1% in August, following +1.0% the prior month. EU27 new car registrations fell sharply in September, from 21% year-on-year growth to 9.2%.

Inflation: the wholesale price index in Germany fell further, down -4.1% year-on-year in September, from -2.7%.


Has Chinese growth bottomed?

China: Q3 GDP exceeded expectations, at 4.9% year-on-year, down from 6.3% the previous quarter. The September data release was also better than estimates, except for the property sector. Industrial production rose 4.5% year-on-year, as it did the previous month, retail sales 5.5% from 4.6%, fixed assets ex rural (i.e., investment) at 3.1% from 3.2%, property investment at -9.1% from -8.8%, residential property sales at -3.2% from -1.5%. New home prices fell 0.30% in September, following -0.29% the prior month. The surveyed jobless rate improved, from 5.2% to 5.0%.

Japan: the tertiary industry index (i.e., services) fell 0.1% in August, from +1.1% the prior month. Capacity utilisation rose 0.5% in August, from -2.2%. Exports and imports improved in September, with exports up 4.3% year-on-year, vs. -0.8% previously, and imports were down -16.3%, from -17.7%.

The national CPI fell from 3.2% to 3.0%, the with “core-core” reading (ex. fresh food and energy) down to 4.2% from 4.3%. The core-core number is the one followed by the Bank of Japan.

Oil/Commodities/Emerging Markets

Risks of further escalation of conflict in the Middle East moves oil higher

Volatility in energy commodity markets remained elevated last week. West Texas Intermediate oil prices rose through the week to close at US$88.75, with Brent crude at US$92. Signs that the conflict in the Middle East could escalate drove prices higher. The Middle East is responsible for 31% of global oil production and 18% of natural gas production. The market that has experienced the most significant impact is Europe’s natural gas market, which is already facing considerable strain due to issues such as the disruption of the Nord Stream pipelines and the imposition of sanctions on Russian natural gas. In recent years, Israel has emerged as a crucial player in the production and export of natural gas. Israel, through its offshore gas fields had been meeting its domestic energy demands and exporting gas to countries like Jordan and Egypt. Egypt, in turn, had been processing Israeli natural gas and shipping it to Europe. However, in the aftermath of the conflict, Israel issued orders to halt operations in one of their fields, causing a notable surge in natural gas prices in Europe.

Another important mover affected by the situation in the Middle East was gold, surging 2.5% last week to US$1,981, driven by ‘safe haven’ seekers, as most other investments have fallen since the recent surge in conflict began.

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