Markets last week
There were massive changes last week in government bond markets, which resulted in a marked rise in yields in the US against a large drop in yields in the UK.
In the US, the economic discourse has become extremely hawkish, with three Fed officials raising the prospect of bigger rate hikes from the US Federal Reserve (Fed). Indeed, economic data has been resilient in the US (industrial production, capacity utilisation, jobless claims). Housing is visibly falling but this is not new for investors and the slow drip downward of most surveys is not signalling a major change ahead for the economy. Markets are arguing that the Fed is not yet managing to slow down the US economy sufficiently to get rid of inflation; as a result, the tightening will have to continue for longer and reach higher rates than previously forecast. A peak above 5% for Fed funds is now expected for next year.
This has driven US treasury bonds to the longest slump since 1984. 10-year treasury yields have risen for 12 weeks in a row and climbed to the highest level since 2007. The difference between 2 and 10-year yields fell on Friday to 25 bps as longer-term yields soared whilst short yields rose less. In principle, this indicates a smaller probability of a US recession ahead.
In the UK, however, the political turmoil that led Prime Minister Liz Truss to resign means that fiscal stimulus through tax cuts is now out of the question, so the market can take back all the anticipated rate rises from mid-September. As a result, 10-year gilt yields fell briefly below 4% and have settled at a lower level than treasury yields for the first time in a month. The expectation is that the Bank of England (BoE) may have less work to do now that fiscal thrust is out of the picture.
In addition, Ben Broadbent, Deputy Governor of the BoE, said that it’s not clear that UK interest rates need to rise as much as investors expect. He sees demand slowing along with higher prices, and worries that, if rates follow the current path, it could cause a 5% hit to GDP growth. The economic discourse is therefore completely different in the UK compared to the US. The US dollar took a breather last week and enabled sterling to recover.
This meant that there was once again huge equity market volatility during the week, with 2% up days followed by 2% down days and intra-day reversals abounding. The general direction of equities, however, has taken a more positive turn, whether markets were previously oversold, or the US mid-term elections are galvanising investors ahead of a potential Santa rally.
At the end of the week, US and European equities led with Asia lagging amid worries about the Chinese Communist Party Congress. Today, Chinese and Hong Kong markets dropped sharply due to those concerns. Over the week, cyclical sectors did better than defensives, with energy and information technology neck and neck up over 6%, whereas consumer staples and utilities only managed to eke out a 1% return (in US dollars). Commodities recovered but the difference between the US gauge WTI and the international gauge Brent widened considerably as President Biden tapped further into the US Strategic Petroleum Reserve to keep domestic petrol prices down.
The week ahead
Probably Monday: delayed Chinese statistics for September
Our thoughts: is China slowing down, or recovering? The delay in publishing monthly economic statistics this month due to the Communist Party Congress has highlighted that question. Are the authorities concerned about the data? Whereas the property sector is clearly in a major slump, other areas in the economy were hitherto doing better, led by exports but also consumption. The partial COVID lockdowns still in operation in large parts of the country clearly have an impact in slowing down growth, but how much and where? Industrial production, fixed assets ex rural (i.e. investment), retail sales, exports and imports, property investment and the jobless rate will give us a picture of Chinese growth which has been missing for some time.
Thursday: ECB meeting
Our thoughts: it was only a year ago that any meeting of the European Central Bank (ECB) was dismissed as meaningless by markets, since the ECB had not changed its monetary policy in years. Nothing could be further from that mood now. Every meeting is “live” with large interest rates hikes, as all ECB rates have turned positive and now seem to be trying to catch up with US rates. A 75-bp hike is expected for the main refinancing rate, the marginal lending facility and the deposit facility rate. The ECB tends to have fewer people commenting on its future policy compared to the US Federal Reserve, so the estimated hikes are not baked in the cake. The ECB also has to deal with the real prospect of a severe recession in Europe caused by Russian energy cuts, so the decision may not be that easy for the Governing Council of the ECB. The outcome matters for European markets, in particular eurozone government bonds, which less than a year ago still showed plenty of negative yields and currently range from 2.5% to 5%!
Friday: US PCE deflator
Our thoughts: the PCE (personal consumption expenditures) deflator is an alternative measurement to the better- known CPI (consumer price index). The core PCE (ex energy and food) also happens to be the key gauge used by the Fed to target inflation. Both the headline and core readings are expected to go up in September, which is obviously disappointing, but the main question is whether core rises more than headline, thereby confirming that inflation is spreading through the US economy, which would be a major worry for the Fed. The difference between core and headline has the power to move markets almost more than any other statistic now.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed officials move US yields higher whilst BoE Deputy Governor moves UK yields down
Three senior Fed officials delivered hawkish speeches that moved markets. Minneapolis Fed President Neel Kashkari said: “If we don’t see progress in underlying inflation, or core inflation, I don’t see why I would advocate stopping at 4.5, or 4.75, or something like that.” St Louis Fed President Bullard, who talked about hiking rates by 75 bps in November and 75 again in December, said that companies raising prices are fuelling inflation, not the tight jobs market. Both are on the hawkish side of the Fed. Further, Philadelphia Fed President Patrick Harker said that the Fed will continue to raise rates “for a while” and that won’t stop until “sometime next year” and then “we should hold at a restrictive rate for a while to let monetary policy do its work.”
After all this hawkish rhetoric, a dove flew in: San Francisco Fed President Mary Daly said it’s time to start talking about slowing rate hikes to avoid putting the economy into an “enforced downturn”: “I want to step down from 75-bp hikes”.
There was an important speech by the Deputy Governor of the BoE, Ben Broadbent, which was overshadowed by Prime Minister Liz Truss’s resignation. “Whether official interest rates have to rise by quite as much as currently priced in financial markets remains to be seen. If the bank rate really were to reach 5%, given reasonable policy multipliers, the cumulative impact on GDP of the entire hiking cycle would be just under 5%, of which only around one quarter has already come through.” Broadbent still acknowledged that monetary policy would have to do more depending on the government’s tax and spending plans. “The MPC (Monetary Policy Committee) is likely to respond relatively promptly to news about fiscal policy.”
There was a report that the BoE may delay quantitative tightening (QT) to boost stability in gilt markets, although this was not confirmed by the BoE. The BoE had scheduled 31 October as the QT start. It has nearly £840bn of gilt holdings and had said it intended to complete around £80bn of sales in the next year.
The People’s Bank of China kept rates unchanged, with the one-year loan prime rate at 3.65% and the five-year loan prime rate at 4.30%.
Weaker surveys and housing market but resilient employment
Surveys: the Empire Manufacturing survey (NY State) fell from -1.5 to -9.1, whilst the Philadelphia Fed Business Outlook (known as the “Philly Fed”) edged up from -9.9 to -8.7. Within the details of the Philly Fed, current activity, new orders and unfilled orders were very weak, whereas prices paid and prices received continued to rise – a poor combination. The Leading Index was weaker, down 0.4% in September vs a flat previous month.
Industry: industrial production in September rose 0.4% from a prior negative month. Capacity utilisation increased from 80.1% to 80.3%.
Housing: the NAHB housing market index dropped sharply from 46 to 38. Housing starts in September slumped 8.1% from a previous +13.7% rise. Building permits, on the other hand, went from a negative month, down -8.5%, to a positive 1.4%. Existing home sales dropped 1.5% in September, worse than the -0.8% previous fall. MBA mortgage applications fell -4.5%, after -2.0% the previous week.
Employment: initial jobless claims were lower, at 214K, vs 226K the previous week, an unexpected sign of strength, whilst continuing claims rose from 1364K to 1385K.
Inflation still surging, retail sales falling against the backdrop of limited fiscal room
Inflation: UK inflation once again surprised on the upside, with the CPI rising from 9.9% to 10.1%, the core CPI (ex energy, food, alcohol and tobacco) up from 6.3% to 6.5% and the PPI (producer price index) higher than estimates despite falling slightly (PPI output at 15.9% vs 16.4% and PPI input at 20.0% vs 20.9%).
Housing: the house price index fell from 16.0% year-on-year to 13.6% in August.
Retail: September retail sales disappointed, in part due to the economic impact of Her Majesty’s funeral, down 1.4% including auto fuel or -1.5% excluding auto fuel for a year-on-year drop of 6.9% including fuel or 6.2% excluding it.
Public Finances: the Public Sector Net Borrowing Requirement soared from £8.6bn to £19.2bn in September.
Relentlessly bad surveys and swelling trade deficit
Surveys: the expectations side of the ZEW survey for the eurozone was a tad better at -59.7 vs -60.7. The ZEW survey for Germany remained in the same ballpark, with expectations slightly higher at -59.2 vs -61.9, but the current situation slumping from -60.5 to -72.2.
French confidence was mostly unchanged, with business confidence remaining at 102, manufacturing confidence edging up from 102 to 103, the production outlook indicator falling from -6 to -8 and the business survey overall demand rising from 5 to 13.
Eurozone consumer confidence marginally improved from -28.8 to -27.6.
Industry: EU27 new car registrations rose from 4.4% to 9.6% in September. The construction output for the eurozone fell 0.6% in August vs a +0.3% rise the prior month.
Trade: the ECB (European Central Bank) current account worsened from a deficit of €20bn to €26.3bn.
Inflation: the German PPI had a better month in September, at 2.3% vs 7.9% previously, but the year-on-year PPI remained at an eye-watering 45.8%.
Debt: the eurozone government debt to GDP ratio was fairly stable, at 95.4% in 2021, vs 95.6% previously.
Delayed September data for China shows a generally slower economy whereas Japan is more resilient
China: monthly economic statistics were withheld during the session of the Chinese Communist Party plenum until the weekend. Q3 GDP growth was set at 3.9%, higher than expected. In September, industrial production rose 6.3% year-on-year, an increase from 4.2% the prior month; retail sales were up 2.5%, down from 5.4%; fixed assets ex rural (i.e. investment) edged up to 5.9% from 5.8%; property investment fell further, down -8.0% from -7.4%; exports slowed down to 5.7% from 7.1% with imports flat at +0.3%; and the surveyed jobless rate unexpectedly increased to 5.5% from 5.3%.
Japan: the tertiary industry index (i.e. services) turned around from -0.6% to +0.7% in August. Capacity utilisation in August was lower, at 1.2% vs 2.4% the prior month. Japanese exports were very strong in September, increasing 28.9% year-on-year, up from 22.0%, with imports rising 45.9%, down from 49.9%.
The national CPI was unchanged at 3.0%, with the core CPI ex fresh food and energy rising from 1.6% to 1.8%.
The Jibun Bank PMIs were solid, with the manufacturing PMI almost unchanged at 50.7 from 50.8 but the services PMI rising to 53.0 from 52.2.
Crude oil gauges affected by the US drawing down its Strategic Petroleum Reserve
There was less focus from the markets on commodities during the past week, as bond yields dominated the scene. The news from Ukraine is also providing less support to energy prices. Importantly, we have seen European gas prices collapsing as the EU has replenished its gas storage tanks through both pipeline and LNG imports. Against that backdrop, oil prices were well sustained, with Brent rising 2%, although the difference between the US gauge WTI and the international gauge Brent widened considerably as President Biden tapped further into the US Strategic Petroleum Reserve to keep domestic petrol prices down ahead of the mid-term elections in a fortnight.
Copper rose despite the weakening global economy and gold rallied after fighting soaring bond yields, which are a competitor for defensive investors’ attention.