Markets last week
Global stockmarkets delivered their third consecutive week of gains, although the week in Europe began on a poor footing, as disappointing economic growth figures from China weighed on sentiment. Meanwhile, surging energy prices added to prevailing inflation concerns and sent bond yields higher. After the Monday opening in the US however, energy prices began to fall back, which allowed US stocks to gain ground and fed through to a positive Tuesday opening in Asia and Europe.
European natural gas contracts soared by almost 20% on Monday to over €100 per megawatt hour as hopes dwindled that Russia might step in to help alleviate the gas shortage; however, they then stabilised at near €90 on Tuesday. Similarly, Brent crude, which had been pushed higher as energy-intensive businesses switched from gas to oil, rose as high as $86 a barrel, before slipping back to close out the week at $85.53.
UK Gilt yields also surged after the Bank of England warned of a need to respond to price pressures with tighter monetary policy, which was responsible for the yield on 2-year paper rising from 0.58% at the end of the previous week, to 0.72% by close on Monday. Financial markets also responded by bringing forward their expectations for the first rise in UK interest rates to November, and now expect rates to reach 1.25% by the end of 2022, which would be the highest level since the 2008-2009 global financial crisis. Money markets are currently signalling that these interest rate rises could be a mistake, and that the Bank of England may need to reverse course quite quickly.
By mid-week, the US stockmarket was again testing its all-time high, despite inflation expectations continuing to rise. The 10-year US breakeven rate (an implied measure of expectations for inflation over the next 10-years) rose to 2.59%, its highest level since 2012. As far as the stockmarket was concerned, positive corporate earnings helped to dissipate concerns that cost pressures – driven by the strains in the energy market and supply chain issues – could disrupt the economic recovery. That said, current tracking estimates for US real GDP in the third quarter have continued to fall, with the Atlanta Fed GDPNow forecast just barely in positive territory at 0.53%.
All of these economic concerns were not sufficient to derail the bull run in the US stockmarket which, during the week, registered its 57th and 58th all-time highs this year.
The week ahead
Wednesday: UK Budget
Our thoughts: the UK Budget comes at a particularly difficult juncture and is set against a backdrop of soaring inflation and expectations for imminent interest rate rises. Chancellor of the Exchequer Rishi Sunak is highly likely to deliver an extremely cautious message, albeit he will provide forecasts which upgrade economic growth expectations and paint a healthier picture for public finances. Growth for 2021 will likely be revised higher to 6.3%, although the figure for 2022 may be cut. We expect the borrowing figures for this year to be revised downwards, as supported by this week’s budget deficit figures. Media reports suggest Sunak will aim to balance day-to-day spending with revenue over a three-year period and to bring the underlying debt burden onto a downward path.
Thursday: European Central Bank (ECB) interest rate decision
Our thoughts: the biggest decision facing the ECB will likely come in December, when they will determine their future policy on asset purchases. However, the foundations for these decisions will likely be laid on Thursday when President Christine Lagarde could set out the view that the recent increase in inflation readings are still a temporary phenomenon. This will leave sufficient room for the ECB to increase the pace of the monthly bond buying programme in March, when the current Pandemic Emergency Purchase Programme expires. We expect the Governing Council to look through the temporary impact of the rise in energy costs and focus on the fact that underlying price increases are still subdued and there is ample labour market capacity. Risks to the economy are still likely to be viewed as ’broadly balanced’.
Thursday: US GDP
Our thoughts: economic activity in the third quarter will undoubtedly reflect weaker consumer and business spending, as supply chain bottlenecks and product shortages acted to constrain growth. Personal consumption growth is likely to have deteriorated significantly, while we expect that residential investment will also decline, with construction activity being limited by supply and labour shortages. Trade is also likely to have detracted from growth while business investment on equipment and structures will fall given both supply chain disruptions, rising costs and an underlying shift away from office space. The only positive is likely to come from inventory levels, which may fall at a slower rate than in the second quarter.
Markets for the week
|In local currency||In sterling|
|Index||Last week||YTD||Last week||YTD|
|Hong Kong equities||3.10%||-4.10%||3.20%||-5.00%|
|Emerging market equities||0.70%||0.10%||0.80%||-0.60%|
|Government bond yields (yield change in basis points)|
|Current level||Last week||YTD|
|10-year US Treasury||1.63%||6||72|
|10-year German Bund||-0.11%||6||46|
|Current level||Last week||YTD|
|Commodities (in USD)|
|Current level||Last week||YTD|
|Brent oil (bbl)||85.53||0.80%||65.10%|
|WTI oil (bbl)||83.76||1.80%||72.60%|
|Copper (metric tonne)||9704||-5.60%||25.00%|
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
An imminent rise in UK interest rates is expected
Bank of England Governor Andrew Bailey outlined a case for an early interest rate increase by highlighting that the central bank will “have to act” to contain inflationary forces and fired a warning that higher energy costs may mean that pricing pressures will linger. The Bank of England chief economist warned that UK inflation may hit 5% in the months ahead, but urged investors not to become too fixated on the exact timing of any rate rise and instead simply focus on the larger picture, which is that the UK economy no longer requires interest rates at an emergency low level of 0.1%
The chances of Jerome Powell, the US Federal Reserve (Fed) Chairman, being renominated for a second four-year term by President Biden have decreased following the disclosure that he sold upwards of $1m of stock, and potentially as much as $5m, at the beginning of October 2020. This occurred shortly before the US stockmarket experienced a significant decline and came as Powell was appealing for Congress to pass a second COVID-19 relief bill. Late in September this year, the presidents of the Federal Reserve Banks of Boston and Dallas announced they would step down after it was revealed that they too had undertaken similar, extensive stock trading in 2020 while the US Federal Reserve was spending trillions to stabilise financial markets.
While such trading is not illegal per se, it raises serious questions around potential conflicts of interest and has prompted Senator Elizabeth Warren to publicly call for the Securities and Exchange Commission (SEC) to investigate whether trading rules were broken.
The Fed has now adapted it rules and has banned policymakers and senior staff from buying individual shares and many other investments. In addition, those impacted by the rules will need to provide 45-days’ notice for any purchases or sales of securities and obtain approval for those transactions, as well as holding any investments for at least a year.
Slower growth, higher inflation
Housing: US housing starts decreased in September as continued supply chain constraints, shortages of skilled labour and increased material costs led to a pullback in multifamily (apartment building/condominium) construction. Residential starts fell 1.6%, while applications to build, which are an indicator of future construction, fell 7.7%, the largest monthly decline since February. Again, this drop was driven by sharp falls in multifamily permits. There is also little sign that builders are catching up with backlogs; the number of single-family homes authorised for construction but not yet started, fell slightly to 144,000, but remains near a 15-year high.
Sales of previously-owned US homes rose by the most in a year; contract closings increased 7% from the prior month, the most since September 2020, to an annualised 6.29 million. According to the National Association of Realtors, “Housing demand remains strong as buyers likely want to secure a home before mortgage rates increase even further next year.” The median selling price of an existing house rose 13.3% in September from a year ago, to hit $352,800, although this was the smallest annual price increase since the end of 2020. Properties remained on the market for an average of 17 days last month and 86% of the homes sold in September were on the market for less than a month.
Output: US industrial production fell 1.3% in September, far below expectations for a 0.1% rise. A large part of this undershoot can be attributed to outages relating to Hurricane Ida, which were estimated to have subtracted 0.6% from production. While output of chemicals and energy products were impacted by Ida, supply shortages constrained vehicle production, and utility output also dropped on lower cooling demand as temperatures moved more towards their seasonal norm after a warmer-than-normal August. Manufacturing production fell 0.7%, following a revised 0.4% decline in August. The report showed that motor vehicles and parts output fell 7.2%; the sharpest drop since April as a global shortage of semiconductors continued to weigh on production.
Employment: initial jobless claims fell to 290,000, the lowest level since March 2020, led by declines in Virginia, Michigan and Pennsylvania, although filings in California surged by 17,570. Continuing claims fell 122,000 to 2.481 million.
Budget deficit: the US recorded its second-largest budget deficit of $2.77trn for the fiscal year through September (compared to $3.1trn for the previous year). While this is a massive number, it was better than the $3trn estimate from The Congressional Budget Office (CBO), who now forecast a $1.15trn deficit for 2022. However, the figure for 2022 could yet be inflated by a further two packages; firstly, a $550bn bipartisan infrastructure bill which has passed the Senate and is awaiting adoption by the House. Secondly, Democrats are also still negotiating a social-spending bill that could add $2trn over the next 10-years, although President Biden has pledged that this will be paid for by revenue measures.
Surveys: the US Federal Reserve’s Beige Book report supported the current narrative of a continued economic recovery, but one in which price pressures have grown considerably. According to the report, economic activity grew at a “modest to moderate rate”, although several districts highlighted that the pace of growth slowed in the period, constrained by supply chain disruptions, labour shortages and continuing COVID-19 uncertainty. Most districts also reported “significantly elevated prices”, which were also driven by supply shortages, transportation bottlenecks, higher raw material costs and labour constraints. It seems that many firms were able to raise selling prices in response to higher input costs, reflecting a greater ability to pass along cost increases to customers and strong demand. Not only are firms struggling to attract workers, but they are having difficulty retaining employees: “firms reported high turnover…child-care issues and vaccine mandates were widely cited as contributing to the problem.”
The Philadelphia Fed business outlook survey fell to 23.8, from 30.7 in September and below the consensus forecast of 25.0. Underlying readings for new orders, shipments and employment all improved within the current conditions components, while capex plans also rebounded. So too, the outlook for six-months ahead also improved, although this measure still remains near the low end of its range over the past 10-years. Measures of current and expected prices remain at elevated levels, but it appears that factories are able to pass on cost increases, with expectations for prices received outpacing those for input costs in two of the past three months.
The IHS Markit composite PMI reached a three-month high, boosted by the services element, while manufacturing cooled. The composite measure rose to 57.3, from 55; services rose to 58 from 54.9, while the manufacturing PMI dipped to 59.2 from 60.7.
A temporary lull in inflation; expect worse figures to come
Inflation: UK Consumer Price Inflation (CPI) slowed marginally in September, dropping to a 3.1% annual pace, from 3.2% in August. Core CPI (ex food and energy) similarly dropped to 2.9% from 3.1%. The drop in the headline rate was partly due to the fact that restaurant prices rose less than the previous year, when the ’Eat Out to Help Out‘ scheme ended, which caused prices to spike higher. It is widely expected that this slight reprieve will be short-lived, and that inflation will jump again next month before moving to over 4% by the end of the year. Meanwhile PPI Output (the cost of manufactured products leaving UK factories) rose 6.7% from a year earlier, compared to 6.0% in August. Input prices into factories were 11.4% higher than a year ago.
Public finances: the UK budget deficit reached £108.1bn between April and September; 30% below the £151.6bn forecast by the Office for Budge Responsibility (OBR). September’s deficit alone stood at £21.8bn, although again this was lower than expected. Public finances are benefitting from a more robust recovery from the COVID-19 lockdowns and, as it stands, government borrowing looks like it will significantly undershoot the £234bn forecast by the OBR. Reducing the deficit could be challenging given the cost of government debt, which is running 50% higher than this time last year, combined with the implications of the spike in inflation. One-quarter of the national debt is linked to retail prices. Tax revenue was 11% higher in September compared to 2020, while total income in the first half of the year was up nearly 16%. Government spending was 1.6% lower compared to September 2020.
Surveys: the flash composite PMI reading for October surprisingly rose to 56.8, compared to 54.9 previously and expectations of a decline to 54. The services component rose to 58 (consensus 54.5; prior 55.4) while the manufacturing PMI stood at 57.7 (consensus 56; prior 57.1). The survey also supported the view that inflationary pressures have intensified, while supply constraints have shown few signs of easing.
Retail sales & consumer confidence: UK retail sales unexpectedly fell for a fifth consecutive month, which is the longest consecutive period of monthly declines on record. This came despite panic buying for fuel. The volume of goods sold in shops and online fell 0.2% on the month and 1.3% year-on-year. Excluding fuel, the figures were even worse, with a 0.6% month-on-month and 2.6% year-on-year decline. It appears that fuel shortages, wet weather and low consumer confidence all played a part, with sales of household goods, furniture and books all significantly impacted.
Consumer confidence slumped in October according to a separate survey from GfK, and the biggest concern relates to consumers’ views on the future economy. Sentiment dropped four points from September, to minus 17, the lowest reading since February amid spiralling concerns about an impending cost of living crisis.
German auto manufacture is depressing activity
Survey: the PMI survey data for October showed a fall in the composite reading to 54.3, from 56.2, which was a worse reading than expected (consensus 55.2). Services were the driving force behind the deceleration in growth, with the services PMI falling to 54.7, from 56.4, while the figure for manufacturing only marginally contracted to 58.5 from 58.6. It appears that Germany is the main culprit from a country perspective, as its composite figure dropped to 52.0 from 55.5, which may not be too much of a surprise when it is considered that auto vehicle manufacture and sales are being most impacted by supply chain disruptions and semiconductor shortages.
China is experiencing a sharp slowdown
China: Chinese economic growth was reported to have slowed significantly in the third quarter, with both the property sector and energy shortages exacting a toll on activity. GDP grew just 4.9% year on year, a sharp slowdown from the 7.9% pace of the second quarter. Quarter on quarter growth was a mere 0.2%. There does not appear to be any rush on the part of the country’s leaders to provide stimulus to the economy, suggesting that growth may remain constrained moving forward. In addition, industrial output rose 3.1% in September, below the 3.8% figure expected, although retail sales expanded 4.4%. Meanwhile, the jobless rate fell to 4.9%, while fixed-asset investment climbed 7.3% in the first nine months from a year ago, lower than the 7.8% forecast figure.
It was also reported that Evergrande, the highly indebted Chinese property developer, had paid an interest payment on a US dollar bond, just prior to a deadline which would have trigged a formal default. The initial missed September 23 deadline sparked an uptick in volatility, and a slump in the Chinese property sector. While this last-minute payment has been made, Evergrande has US$7.3 billion of bonds maturing next year and without significant restructuring, the future of the company remains in grave doubt.
Japan: Japan’s export performance was also hurt by supply chain disruptions, with auto shipments in particular plunging, thereby undermining one of the key pillars of the country’s economic recovery. Export growth slowed to 13%, one-half of August’s growth rate, although this was marginally better than the 10.5% growth rate expected. Auto shipments fell 40% from last year’s level, led by a drop in exports to the US, where overall shipments fell for the first time in seven months. Japan’s total exports are, however, still 7% above their 2019 level. Higher oil prices, medical supplies and coal were responsible for a 39% rise in imports, which contributed to a 622.8bn yen trade deficit.
Gold traded in a relatively tight $1,764 – $1,795/oz range during the week, while oil prices continued their consistent ascent, with Brent Crude rising by a further 0.32% to finish the week at $85.13. Over the past two months, oil prices have climbed by over 17%.