The numbers for the week – 25 Jul 2022
Markets last week
Last week’s risk market recovery was driven as much by technical covering of short positions, as by fundamental expectations of a future change in inflation-led central bank policy.
Early corporate comments from the earnings season show increasing mentions of inflation, falling demand, tighter financial conditions and the strong US dollar. Also, the number of profit warnings issued by UK-listed companies in the first six months of the year surged 66% as inflation dented earnings, according to a report by consultancy firm EY-Parthenon. This coming week will be meaningful in terms of corporate earnings reports, which could have a significant impact on risk appetite.
The rating agency Moody’s raised its forecast for the global default rate by high-yield issuers to 3.7% from 3.3%, citing credit conditions that are turning more negative. The latest 12-month default rate for that sector was 2.1% at the end of June and the forecast for a 3.7% default is still below the historical average of 4.1%.
Among other influential news items, the collapse in the Italian government and a massive increase in COVID-19 cases in China were offset in market sentiment by Nordstream saying that Russian gas shipments to Europe have resumed, albeit at a low level.
Against that backdrop, the European Central Bank (ECB) raised interest rates by 50 bps, bringing its deposit facility rate to 0% after eight years of negative rates. In addition, the ECB announced the new ’anti-fragmentation‘ vehicle, the TPI (Transmission Protection Instrument), which is designed to help peripheral European country credit spreads from rising too much above the core country, Germany. Although few commentators openly praised the TPI, the overall takeaway from the ECB meeting was seen favourably by risk markets.
Despite relentless inflation statistics (the latest 9.4% in the UK), markets are refocusing their attention on growth rather than prices. Growth expectations have been brought downward in most western economies, as witnessed by major drops in some economic surveys (US services PMI and Leading Economic Indicators, UK consumer confidence, eurozone manufacturing and services PMIs). In the process, the expectation of future rate hikes by central banks has been reduced by one or two 25 bps increases. It remains to be seen whether the US Federal Reserve (Fed) will endorse those revised forecasts during its meeting this week.
At the end of the week, there were large drops in government bond yields with the bellwether US 10-year treasury bond yield down to 2.75% and 10-year gilt yields below 2%. Despite a last-minute fall in the US on Friday, equity markets rallied sharply, with riskier areas like the FTSE 250 and European equities doing best, but also Japanese shares which have been steadily climbing over the past few weeks. The best sectors were the cyclical ones, with consumer discretionary, industrials, technology and energy at the helm. Oil prices moved decisively down in the US, with the WTI (West Texas Intermediate) gauge more than US$8 below Brent, whereas copper rallied more than gold as befits a ‘risk-on’ mood.
The week ahead
Wednesday: meeting of the US Federal Reserve (Fed)
Our thoughts: a lot of market expectations are resting on the Fed delivering the expected 75 bps rate hike this week, but also on comments supporting the market’s view that the Fed will be willing to alter its policy later this year. Nothing can be taken for certain in that respect and, although comments from Fed Chair Jay Powell will be parsed carefully as ever, markets will react quite fast to the Fed, either going along with their view or not. There could therefore be a very sharp reaction if the Fed disappoints investor expectations.
Friday: eurozone CPI
Our thoughts: inflation in the eurozone is characterised by a large distance between the headline number and the core reading (almost 5% last month). This means that energy and food prices are overwhelmingly responsible for the current surge in the CPI (consumer price index). Although a small increment is expected this month for both core and headline, the size of the increase and the difference between the top and bottom readings will matter to investors. Some are concerned that Europe might get into a recession on its own, without much influence from ECB interest rate hikes, and hence don’t want to see sticky inflation (as in the US).
Friday: US PCE deflator
Our thoughts: although the Fed meeting will be over by the time of the next PCE (personal consumption expenditures) inflation number, the number will nevertheless matter to markets which are focusing on future rate policy changes rather than this month’s hike. The core PCE is the official gauge followed by the Fed and the level has stayed way below headline CPI. Even the headline PCE deflator is a couple of percent below the CPI. The main difference between the inflation numbers is the percentage of housing costs in the calculation, which is much higher for the CPI than the PCE. At this stage, the Fed cannot afford to overlook one index and hence will pay attention to all inflation measurements.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
The Bank of Japan (BoJ) did not change its rates, but raised its inflation forecast to 2.3% (a number that the rest of the world will envy) and downgraded growth by 0.5% to 2.4%.
The People’s Bank of China (PBoC) left its prime rates unchanged, with the one-year loan at 3.70% and the five-year loan at 4.45%.
The Bank of England (BoE) will consider a half-point interest rate increase in August, Governor Andrew Bailey said. Markets have been discounting the BoE’s first 50 bps hike since gaining independence in 1997. The BoE is also looking at a total reduction in the stock of gilts, i.e. some form of quantitative tightening (QT).
The European Central Bank (ECB) delivered a 50-basis point hike, finally moving out of negative territory after 8 years. This was only the third time in the ECB’s history that it has raised rates by more than 25 bps. From now on, the ECB is largely giving up forward guidance, instead noting that policy decisions will be taken on a meeting-by-meeting basis. The new anti-fragmentation tool, the Transmission Protection Instrument (TPI), is designed to help keep peripheral spreads in check and is likely to be triggered if Italy-Germany spreads get too wide. This could well happen soon, if the Italian political situation continues to put upward pressure on BTP (Italian government bonds) yields and downward pressure on the euro. The euro went up after the ECB meeting, but it didn’t last more than a couple of hours.
Housing softer, jobless claims rising and surveys collapsing
Housing: homebuilder sentiment fell in July to the lowest since May 2020 due to inflation and higher interest rates. The NAHB (National Association of Home Buyers) gauge decreased to 55, down 12, the largest monthly drop since the start of the pandemic. Housing starts fell 2% and building permits 0.6%. Existing home sales dropped 5.4% in June and mortgage applications were down 6.3% on the week.
Surveys: the New York Fed’s business survey showed significant declines in the prices-paid and prices-received diffusion indices. The LEI (leading economic indicators) dropped 0.8% in June, the steepest slide since April 2020 during the height of the pandemic. The Philadelphia Fed Business Outlook survey dropped from -3.3 to -12.3, against estimates of a positive number. The S&P Global manufacturing PMI was slightly lower at 52.3 vs. 52.7 but the services PMI collapsed from 52.7 to 47.0.
Employment: jobless claims continued their slow climb, with initial claims now at 251K vs. 244K and continuing claims at 1384K vs. 1333K. Initial claims bottomed at 166K in March.
Soaring inflation, conflicting surveys and resilient jobs market
Employment: the number of employees on payrolls increased by 31,000 in June. The gain followed another 31,000 rise in May (revised from 90,000) and was below the estimated level of 68,000. The number of employees is now 561,000 above the pre-pandemic level with vacancies significantly above pre-COVID-19 levels at 1.29 million.
Inflation: regular wage growth rose to 4.3% in the three months to May, but including bonuses, fell to 6.2% from 6.8% in April. The CPI surged from 9.1% to 9.4%, above estimates, with the core CPI slightly lower at 5.8% vs. 5.9%. The PPI (producer price index) was also much higher: with the PPI input and PPI output at 24% and 16.5%, respectively.
Public finances: the UK budget deficit was £22.9bn in June, up 20% from same month last year. The gap for the first three months of the fiscal year is £55.4bn, £3.7bn more than the OBR (Office for Budget Responsibility) forecast in March.
Surveys: the GfK consumer confidence survey fell to a 48-year low. The S&P Global PMIs fell moderately, with the manufacturing PMI down from 52.8 to 52.2 and the services down from 54.3 to 53.3.
Consumer: retail sales in June were down 0.1% including auto fuel, or up 0.4% excluding auto fuel, both better than estimates.
Housing: the house price index rose from 11.9% year-on-year to 12.8% in May.
Surveys: the S&P Global PMIs for the eurozone fell sharply, with manufacturing down from 52.1 to 49.6 and services from 53.0 to 50.6, below estimates. Consumer confidence in the eurozone fell from -23.8 to -27.0.
Construction: the eurozone construction output rose 0.4% in May, up from -1.0% the previous month.
Balance of payments: the ECB current account deficit increased from €3.9bn to €4.5bn in May.
Japan’s inflation continues to defy the rest of the world
China: no meaningful statistics.
Japan: exports were up 19.4% year-on-year in June, better than the prior month, with imports up 46.1%, a little worse. The national CPI (consumer price index) eased from 2.4% to 2.5%, with the CPI ex fresh food and energy rising from 0.8% to 1.0%. The PMIs fell, with the Jibun Bank manufacturing PMI down from 52.7 to 52.2 but the services PMI dropping more sharply from 54.0 to 51.2.
US oil prices falling, but copper and gold recovering
US oil prices slumped. The WTI gauge tumbled ending at US$94.7/bbl on the week. Part of it was due to a drop in fuel consumption in the US, but there was also an important increase in crude output. Libya started restoring production with output rising above 700,000 barrels a day after restrictions on exports were lifted. Output is expected to return to 1.2 million barrels a day within a week to 10 days.
Oil prices have erased almost all of their post-war gains in recent weeks. Retail fuel prices in the US have now been falling for 37 days.
There is a large difference now between Brent and WTI, topping US$8.
Both copper and gold rallied, but with copper up 3.6% whilst gold was up only 1.1%, markets were clearly giving a ‘risk-on’ signal.