The numbers for the week – 26 Jun 23
Markets last week
Risk markets struggled over the last week – even without being open to reflect the extraordinary events in Russia over the weekend. A combination of worries over economic growth, a sense that exuberance may have been over-played in the leading technology stocks, declines in key commodities and lingering concerns over inflation, especially in the UK, combined to drive equities lower.
The biggest laggards lay in economically sensitive sectors: real estate fell 4.4%, materials 4.0%, energy 3.4% and financials 2.6%. There was a very tepid response to the latest Chinese interest rate reductions; and this was added to fears over the mid-tier banks in the US and their exposure to real estate and a fall in the price in crude oil. Conversely, classic defensive sectors held up better, with communication services down only 1.1%, consumer staples by 0.7% and healthcare by 0.6%. Nonetheless, all sectors fell. Stylistically, of the major factors value fell the most, down 2.5%, with quality holding up best but still down 1.9%.
Geographically and expressed in a common currency, the US held up best, down only 0.4% in sterling. Elsewhere it was more difficult: the laggard was China, with Hong Kong shares down 4.9%. Emerging markets more widely fell by 2.7%, Europe excluding the UK by 2.3% and Japan by 1.9%. The UK itself fell by 2.7% with a particularly difficult performance from smaller companies; the FTSE 250 fell by over 5%.
In this sombre environment, fixed interest did better across the board, led more by government bonds than by credit, although the latter also saw positive returns. Even in the UK Gilts market, which was absorbing the implications of poor inflation data and a larger than expected interest rate rise from the Bank of England (BoE), yields fell, and prices rose. The UK 10-year Gilt closed with a yield of 4.3%, having approached 4.5% at one stage. Declines of almost as much were seen in US and German 10-year government bond yields, which fell to 3.7% and 2.4% respectively. Year-to-date, the UK Gilts market remains the worst performing of all major government bond markets, down 3.4%. Disappointing after the dreadful performance of 2022.
There were no hiding places in commodities. The price of Brent crude fell by 3.6% and is now down 14% for the year. Even gold, which has acted as a good diversifier over the last two years, fell by almost 2%, although it remains up 5% for 2023 as a whole.
In currency markets, the effect of the UK inflation and rate rise news was to reverse some of sterling’s recent strength. It fell back to $1.27 against the dollar and €1.17 against the euro. The Japanese yen was notably weak again, falling 1% on a trade-weighted basis.
The week ahead
Monday: IFO business climate indicator published in Germany
Our thoughts: The recent confirmation that the eurozone had fallen into a very shallow recession, with two consecutive quarters of 0.1% declines in GDP, will draw the focus toward the IFO indices, published on Monday. Consensus forecasts see further weakness, with marginal declines predicted for the overall measure, down to 90.7 from 91.7 last time, and for the current conditions and future expectations components.
Over the last few months the index has recovered from lows of around 85, and there has been some evidence of better sentiment in recent Purchasing Manager Indices (PMI). So it would be no surprise were we to see a slightly better than expected outcome for the headline number. The European Central Bank is in a hawkish mood; any excessive strength will only go to reinforce their stated intention to increase rates in the upcoming July meeting.
Friday: EU CPI data
Our thoughts: After the disappointment of seeing UK core Consumer Price Index (CPI) rising in last week’s data release, it will be the turn of the EU to show whether it can do better. Last time the print came in at 6.1% year-on-year, and expectations are for a further decline to 5.6% this time, driven by some of the smaller economies.
However, in the case of Germany we may see a similar dynamic to that seen in the UK. The monthly CPI rises in May, June and July 2022 were rather small, so unless these are replaced by still smaller numbers this time, it is quite possible we will see an increase in German inflation over this period, Market expectations are correspondingly downbeat, with a forecast raise from 6.1% last time.
Friday: US core Personal Consumption Expenditures index (PCE) for May
Our thoughts: Core PCE is the US Federal Reserve’s (Fed) preferred inflation measure, so this will be key to framing the Fed’s debate whether to raise interest rates again at their July meeting. Last month, April saw a disappointing rise from 4.6% to the current 4.7% level, and the rate of increase has stayed between 4.6% and 4.7% since December 2022. The equivalent month this time last year was neither especially weak nor especially strong, and market expectations are for no change this time, with a consensus forecast of 4.7%.
Any evidence that inflation remains worryingly more persistent will only encourage the hawks in the Fed; markets are pricing in two further rises of 0.25% in the Fed Funds rates until it peaks at an upper bound of 5.75% later in the year. As elsewhere, these expectations can change rapidly in the event that a worse than expected number is published. Any further increases in interest rates in the US already risk tipping the economy into recession, and evidence that a higher terminal rate is likely would weigh on risk assets.
The numbers for the week
Central banks/fiscal policy
Early in the week the People’s Bank of China (PBoC) cut its reference one and five-year loan prime rates by 10 basis points (0.1%) to 3.55% and 4.20% respectively. One of the few central banks worldwide to be actively cutting rates, the PBoC remains concerned by weakness in the crucial property market and by the anaemic bounce-back in consumption following the removal of almost all COVID-19 restrictions at the beginning of the year. Local markets reacted to the cuts with disappointment, having hoped for a more meaningful reduction.
On Thursday the BoE increased rates more than expected to 5.0% from 4.5% (most had predicted a 0.25% increase), following poor inflation numbers the previous day. Markets now expect a further 1.25% increase over the remainder of the year to a terminal rate of 6.25%, although this may be tempered either by better inflation news, which is especially likely in the autumn, or by evidence of a sharp contraction in housing activity following well-publicised and very large increases in average monthly repayments.
United States
Stronger data from the housing market complicates the Fed’s calculations
Surveys: The Chicago Fed national activity index weakened, coming in at -0.15 compared to +0.14, and the Kansas City Fed’s composite and manufacturing indices also softened, falling to -12 and -10 from -1 and -2 respectively. These were reinforced by the release of the S&P PMI indices, which showed a decline in the manufacturing index to 46.3 from 48.4, in services to a still robust 54.1 from 54.9 and in the composite to 53.0 from 54.3. Despite some signs of stabilisation, manufacturing activity remains under pressure in the US.
Housing: There was a string of housing data to digest. The National Association of Home Builders (NAHB) housing market index moved higher to 55 from 50 previously, stronger than expectations. This strength was reinforced by sharply higher housing starts, up 21.7% from the previous month, with permits, a more forward-looking measure, also firm, up 5.2% to 1.491m. Existing home sales were robust at a 4.3m annual rate; these give a good indication of short-term activity as typically major ancillary purchases of white goods and soft furnishings occur around sales completions. Finally, the Mortgage Bankers Association 30-year mortgage rate declined modestly to 6.73% from 6.77% the previous week.
Employment: The weekly initial jobless claims data showed 264k claims, the same as the previous week. The four-week moving average increased to 255.75k from 247.25k. The Fed will be looking for much higher numbers than these to prompt a more dovish approach to interest rates. Continuing claims actually fell to 1.759m from 1.772m. The jobs market in the US remains very tight.
United Kingdom
Disappointing inflation data the lowlight of the week
Surveys: The CBI industrial trends new orders index climbed very slightly to -15 from -17. Nonetheless, the S&P PMI indices showed a continuing weakening: the manufacturing PMI fell to 46.2 from 47.1, the services measure to 53.7 from 55.2 and the composite to 52.8 from 54.0. Even through the GfK consumer confidence index strengthened a little to -24 from -27 (still recovering from the lows last September of -49), it remains weak. There is little evidence of better growth conditions from these.
Inflation: Inflation numbers released on Wednesday were a deep disappointment. Although there were falls in fuel costs (-13.0% this time compared with -8.9% last time) and food inflation slowed to 18.3% from 19.0%, these were not enough to offset rising prices in air travel, theatre and cinema tickets and second-hand cars. The headline rate remained unchanged at 8.7%. Worse was to come from the core rate, which excludes energy, food, drink and tobacco, which rose to 7.1%, the highest since March 1992. The Retail Price Index (RPI) measure, still used in some pension contracts, for council tax and for student loans repayments, rose 11.3%, only a tiny amount down from the previous month’s 11.4%. A large component of RPI comes from rising mortgage payments, and the pressure from these is unlikely to abate soon.
The gloom was made worse by average earnings data that showed a 7.2% increase in wages over the year. The BoE has made great measure of this as a worrying indicator for future inflation, as it seems to indicate the onset of a wage/price spiral.
There was slightly better news from Producer Price Inflation (PPI), which fell to 4.1% from 6.0% last time, although this is still high compared to several of the UK’s international competitors.
These poor figures prompted the BoE to raise rates more aggressively than expected, as discussed above.
Retailing: UK retail sales fell by 2.1% year-on-year in the month. Although this was the fourteenth consecutive month of negative readings, this was in fact the smallest decline of that period, and it is likely we are close to the end of this negative run. There is some evidence higher pay awards are prompting continued spending in the high street
Government finances: Although better than the previous month, the outcome for May, at a Net Public Sector Borrowing Requirement of £19.2bn was significantly worse that estimates of £14.9bn, reflecting the parlous state of government finances in the UK and giving Chancellor of the Exchequer Jeremy Hunt less headroom to make any tax give-aways before the next general election, due in January 2025.
Europe
Mixed numbers but better news on input cost inflation
Surveys: French business confidence improved somewhat to 101 from 99 last time, and eurozone consumer confidence increased marginally to -16.1 from -17.4.
Car sales: European car registrations increased 18.5% from a year earlier, an increase from the last month’s 17.2% rate. Recovering supply chains and a rather more confident outlook compared with the shock of the Russian invasion of Ukraine last year is driving a return to a more normal production and sales rate.
Inflation: In some contrast to the UK, German PPI fell 1.4% on the month and came in at +1.0% for the year, compared with 4.1% last time. The measure continues to fall from the exceptionally high levels it reached in 2022, having peaked at 45.8% in autumn last year.
A mixed picture in Japan, probably reflecting the weak Chinese recovery
China: As noted above, the PBoC cut interest rates by rather less than some had hoped.
Japan: The monthly Tankan survey increased marginally to 8 from 6 previously, However, the Jibun PMI surveys showed across the board declines, with manufacturing falling to 49.8 from 50.6, services to 54.2 from 55.9 and the composite to 52.3 from 54.3.
Oil/Commodities/Emerging Markets
Worries over Chinese demand and softer economic data in the developed world saw Brent crude decline by 3.6% to $73.85/bl. Although copper was scarcely changed, iron ore fell 0.4% and in precious metals, gold fell by 1.9% to $1,921/oz.
