Markets last week

A large but brief slump hit equities on Monday last week, clobbering investments in the economic reopening. The US 10-year Treasury yield fell below 1.20%, down almost 10 bps. Likewise, UK gilts fell 10 bps to 53 bps.

The stated reason for the large correction was Covid fears, but it was just an excuse, as market leadership had been narrowing considerably over the last couple of months. The weakness in the average stock has contrasted with the strength of the indices for the last two months, so in fact the Monday swoon was part of a longer correction.

Stocks rebounded from the selloff from Tuesday on. All major sectors recovered, but financials did best, with energy and materials close behind. Government bond yields rallied back almost to previous levels. The correction only had a limited impact on inflation expectations, with the US 5-year breakeven now at 2.58%, and 10-years at 2.35%, although the market has pushed back forecasts of US Federal Reserve rate hikes by a couple of months to December 2022.

Sterling was one of the biggest losers of the correction, with problems about travelling from France and the US adding to the “pingdemic” concerns, but it recovered later in the week.

With only about one fifth of companies reporting on Q2 earnings yet, the results are extremely strong, with anywhere from 60% to 90% of firms beating estimates and the growth rate in earnings approaching 100% year-on-year for the US, although it is lower for the rest of the world.

At the end of the week, equities were generally higher, with the US leading, closely followed by UK small caps and European shares, but with Asia losing ground (even before this morning’s Chinese clampdown on the education sector). The best sectors were growth areas like technology and healthcare, whereas the worst were energy and materials. US bond yields were almost unchanged, although other government bond yields fell. The US dollar was a little stronger, oil prices recovered together with copper, but gold somewhat eased.

The week ahead

Wednesday: FOMC (Federal Open Market Committee) decision and communication

Our thoughts: the next meeting of the US Federal Reserve’s Open Market Committee will of course matter enormously to markets. The markets have seesawed between inflation worries and growth scares. Government bond yields have collapsed at the beginning of the past week under the dual belief of slacker growth and a hands-on central bank. The Fed therefore has to clarify its position on inflation and monetary policy. Is tapering (of the Fed’s asset purchases) likely to happen soon or will it be a longer drawn-out process? Have the “dots” (future rates views from individual members) changed further? What is the Fed’s assessment of “substantial progress” on the economy? One way or another, the comments will have an impact on markets.

Friday: China manufacturing PMI and non-manufacturing PMI

Our thoughts: has China peaked? Is that why the People’s Bank of China cut reserve requirements for banks? Is the transition from manufacturing to services doing well or is it exhausting itself? The PMIs should give us a more recent picture of the relative strength of the various parts in the Chinese economy. The scarcity of Chinese data makes the PMIs a vital mirror on the economy.

Friday: US PCE (personal consumption expenditures) inflation

Our thoughts: the PCE core deflator is the Fed’s ultimate inflation gauge and hence will be scrutinised for clues on further monetary policy moves. The recent 3.4% reading is expected to rise to 3.7%, as the headline deflator is also estimated to rise from 3.9% to 4.1%. So far this year, inflation consensus numbers have been beaten across the board. The CPI (consumer price index) numbers definitely topped estimates so the question is whether the Core PCE will as well. The more important issue is which parts of the economy are causing inflation: are they the standard reopening items (rented cars, hotel stays) or have the price rises seeped onto rents and wages? Once again, analysing the details will matter to the markets.

Markets for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

ECB sets very high hurdles to tighten monetary policy

The European Central Bank (ECB) announced a new interest rate policy, sticking to loose monetary stimulus until it can sustainably hit its new inflation goal of a symmetric 2%. This was the first policy review in a long time and ECB President Christine Lagarde said that the Governing Council expects the key rates to remain at their present or lower levels until it sees inflation reaching 2% “well ahead of the end of its projection horizon, and durably for the rest of the projection horizon.”

The ECB currently foresees price growth averaging just 1.4% in 2023. That suggests any rate hike is years away. The Governing Council also said that there could well be “a transitory period in which inflation is moderately above target.”

The current tools were kept unchanged (negative deposit rates, PEPP – Pandemic bond-buying Programme, Asset Purchase Programme, long-term loans to banks).

United States

Negative surprise on jobless claims and services PMI as housing market softens

Housing: the NAHB (National Association of Home Builders) housing market index was a smidge softer at 80 vs. 81 last month – an 11-month low.

US housing starts increased from 6.3% in June to 1.643 million annualised, up 29.1% year-on-year down from 47.8% previously, suggesting residential construction is stabilising despite lingering supply-chain constraints and labour shortages, but permits fell for the 3rd month in a row, down 5.1%, slowing to 23.3% year-on-year to 1.598 million annualised, down from 35.1% previously. Existing home sales rose 1.4% after a 1.2% drop the previous month.

MBA mortgage applications fell 4% for the week after an exceptional +16% the previous week.

Employment: jobless claims disappointed. Initial claims soared from 368K to 419K, whereas continuing claims remained stubborn at 3236K vs. 3265K and way above estimates of 3100K. The unexpected jump in initial claims was caused by outsize increases in 4 states (Michigan, Texas, Kentucky and Missouri) due to a variety of factors including the auto industry seasonal retooling and the rapidly rising delta variant of Covid-19.

Surveys: the Chicago Fed National Activity Index fell from 0.26 to 0.09, defying expectations of a rise. The Kansas City Fed Manufacturing Activity index rose from 27 to 30. The Leading Index rose 0.7% in June after a 1.2% increase previously. The Markit manufacturing PMI kept rising, despite its high level, from 62.1 to 63.1, but the services PMI unexpectedly slumped from 64.6 to 59.8.

United Kingdom

The Chancellor has room in his budget but the “pingdemic” may take it away as PMIs drop

Public finances: confusing data, with the Public Sector Net Borrowing (government budget balance) rising from £19.9bn to £22bn in June but the Central Government Net Cash Requirement falling from £23.9bn to £19.2bn and Public Finances (Public Sector Net Cash Requirement) slumping from £21.7bn to £11.3bn. In general, the budget deficit has been improving with higher taxes as a result of the reopening of the economy.

Retail Sales: retail sales for June rose by 0.5%, much better than expected, with sales ex auto fuel up by 0.3%. The year-on-year comparison was 9.7% and 7.4%, respectively.

Surveys: the CBI Trends surveys showed some moderation in optimism. Total orders eased from 19 to 17, selling prices from 46 to 42 and CBI business optimism slumped from 38 to 27. The Markit manufacturing PMI fell from 63.9 to 60.4, still a very high level, with the Markit/CIPS services PMI dropping deeper from 62.4 to 57.8.

General: it is not clear what the economic impact of the “pingdemic” is. Figures from the NHS show 608,000 people were pinged the week of 19th July, up from 356,000 two weeks before.

Europe

Mixed data but the services PMI is encouraging

The eurozone consumer confidence survey fell from -3.3 to -4.4.

In France, surveys were mixed. Business confidence eased from 114 to 113, manufacturing confidence edged up from 108 to 110, the production outlook indicator fell from 25 to 20 whereas own-company production outlook rose from 18 to 21. Finally, the business survey overall demand surged from 9 to 19.

The Markit manufacturing PMI was slightly softer at 62.6 vs. 63.4, but the services PMI rose from 58.3 to 60.4, with the composite PMI hitting a 21-year high.

China/India/Japan/Asia

Higher imports in Japan means better domestic growth

China: no meaningful data.

Japan: the national CPI (consumer price index) rose from negative to +0.2% in June with the core ex fresh food and energy still at a negative -0.2%.

Japanese export growth was slightly less in June than the previous month, up 48.6% year-on-year vs. 49.6% whereas imports rose to 32.7% vs. 27.9%.

Oil/Commodities/Emerging Markets

Whilst China sold more copper, the metal price nevertheless rallied. Crude oil prices rebounded the most during the week, as risk appetite resumed.