Markets last week
In a week bereft of economic data, central banks and governments shook markets. The US Federal Reserve (Fed) put the final nail in the coffin of expectations for a pivot in monetary policy with one of the most hawkish central bank speeches ever, together with the third 75 basis point (bp) rate hike. During the week, many other central banks raised rates (Bank of England, Swiss, Swedish and Norwegian central banks). The net result was for bond yields to rise significantly across the board as central banks raised their expected policy rates and terminal rates.
Whilst markets were digesting the news of all these rate increases, the Chancellor of the Exchequer in the UK delivered a mini budget which stirred investors from their Friday lethargy. The large tax cuts for households and corporates alike, priced at £161bn for the next five years, would come on top of the energy capping costs for the government, leading markets to wonder whether the country’s debt was sustainable. These misgivings were reflected in soaring gilt yields and a collapsing pound, not just against the US dollar (at an all-time low this morning) but also against the euro, which has obvious challenges of its own due to Russian energy cuts and fragmented politics.
Very few economic statistics came out, with surveys generally softer or mixed at best.
At the end of the week, the US dollar had once again broken a 20-year record against developed currencies, with sterling falling to US$1.086 by Friday (this morning breaking the all-time low of US$1.04), and €1.12, back to post-referendum levels vs. the euro (this morning below €1.10). The Bank of Japan intervened to support the Japanese yen vs. the US dollar for the first time since 1998 as the greenback soared against all currencies.
Government bond yields surged, with US 10-year treasury yields at 3.68%, up 19 bps, and gilts at 3.83%, up an amazing 69 bps and rising more than 2% in the last month alone. Gilt yields have passed treasury yields for the first time in this cycle. European bonds also surged in yield, in particular Italian government bonds, in the expectation of the right-wing populist victory in the Italian elections yesterday.
Equities had another bad week, as a result of all the tumult, but there were wide differences by country. The worst market was the UK, down more than 3%, with small cap stocks under the cosh in part due to the budget. US shares were down 4.6% in dollars but in sterling terms were almost flat. The most defensive markets were Asia and emerging countries. The worst sector was energy, after months of market strength, whereas consumer staples, technology and utilities were the least damaged.
Commodity prices fell sharply, with crude oil down 6-8% depending on the gauge, reflecting an expected global slowdown, irrespective of supply issues.
The week ahead
Thursday: China PMIs
Our thoughts: it is now a standard market comment to hear that China is slowing down. The direction matters, though. Are the PMIs signalling further softness or is the economy more self-sustaining than the West? Manufacturing PMIs have fallen below the 50 threshold between expansion and contraction (both the official CFLP and the unofficial Caixin), but the non-manufacturing PMI is still upwards of 52. Will it hold? Does the supportive monetary and fiscal policy, unlike the US and Europe, help keep economic activity stable?
Friday: eurozone CPI
Our thoughts: unlike in the US, inflation in Europe is still on an uptrend and may not peak for a while yet. Energy costs are largely responsible, as witnessed by the larger differential between the headline and core readings compared to the US, or even the UK. Here too, however, markets will be watching carefully whether inflation is spreading from energy to other items.
Friday: US PCE deflator and core deflator
Our thoughts: once again, markets will be watching inflation data very closely. The PCE (personal consumption expenditures) gauge may be less relevant to the public than the CPI (consumer price index), but the core PCE is the official inflation measurement used by the US Federal Reserve (Fed) in its determination of monetary policy. Like its colleague the CPI, the PCE this month is expected to have dropped but the core PCE is estimated to have risen, once again highlighting that the reduction in price pressures is coming from lower energy costs but that inflation is spreading into more areas of the US economy, which makes the Fed’s monetary policy more difficult.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
From the Fed’s hawkish hike to the Chancellor’s tax-cut spree, neither pleased the markets
The US Federal Reserve (Fed) hiked rates by 75 bps, bringing the Fed funds rate to 3.00-3.25%. This added up to a 3% increase this year. Further, the Fed forecast another 125 bps before year end with two more meetings to go, implying a fourth consecutive 75 bp hike for November. Officials forecast that rates would reach 4.4% by the end of this year and 4.6% in 2023. The range of predictions by officials (known as the ’dot plot‘) is very wide because nobody really knows how far and fast inflation will come down and whether we’ll get just a slowdown or a recession.
The Fed is forecasting a downturn or a mild recession with unemployment rising from the current 3.7% to 4.4%. They also expect GDP to grow by a mere 0.2% this year, down from the previous estimate of 1.7%, with a reduction in 2023 growth from 1.7% to 1.2%. Interestingly, in the long run, the Fed’s estimate of economic growth is only 1.8%.
Fed Chair Jay Powell noted that a pause in rate increases (after getting to restrictive territory) could make sense since policy acts with a lag, but the Fed would have to be confident that inflation is moving back down to target before cutting rates.
The Bank of England raised rates by 50 bps from 1.75% to 2.25%, with three of the nine members of the MPC (Monetary Policy Committee) actually voting for a bigger hike of 75 bps.
During the week, not only did we have the Fed and the BoE, but other central banks were hiking too (the SNB – Swiss National Bank – by 75 bps; the Riksbank – Sweden – by 1% and the Norges Bank – Norway – by 50 bps). Only the Bank of Japan kept interest rates unchanged at -0.10% for its policy balance rate and 0% for its 10-year yield target, but actually intervened in the foreign exchange market to support its currency.
In fiscal policy, the most radical package of tax cuts for the UK since 1972 was unveiled by Chancellor of the Exchequer Kwasi Kwarteng but was not well received by financial markets. The mini-budget reduced levies on both households and companies in an effort to boost the long-term growth potential of the economy, by scrapping the 45% top rate of income tax; trimming the basic rate from 20% to 19%; cutting stamp duty on property purchases; reversing a planned 1.25% increase in payroll taxes and the planned increase in corporation tax from 19% to 25% next year; plus ending a cap in bonus pay for bankers. The total cost of the package, namely £161bn over the next five years, triggered a sell-off in both sterling and gilts, as many in the markets worried about the UK’s debt burden quickly becoming unmanageable.
Tight jobs market and mixed surveys
Housing: housing starts surged 12.2% in August after a very weak July, whereas building permits dropped 10.0%. Existing home sales fell 0.4%. MBA mortgage applications rose 3.8% after a negative week.
Employment: initial jobless claims remained low at 213K this week, after 208K. Continuing claims, however, fell from 1401K to 1379K.The US labour market still looks very tight.
Surveys: the Index of Leading Economic Indicators fell in August for the sixth consecutive month since reaching a new record high in February of this year, dropping 0.3% for the month and 1.0% year-on-year. The Kansas City Fed Manufacturing Activity Index fell from +3 to +1.
The S&P Global Manufacturing PMI was slightly better at 51.8, vs. 51.5, but the services PMI bounced back from a depressed 43.7 to 49.2.
Weaker surveys across the board
Surveys: the GfK Consumer Confidence Barometer fell further from -44 to -49. The S&P Global/CIPS manufacturing PMI edged up from 47.3 to 48.5 whilst the services PMI fell from 50.9 to 49.2.
The Confederation of British Industry (CBI) sales surveys tumbled, with the total distribution reported sales from +11 to -26 and the retailing reported sales from +37 to -20.
The CBI trends surveys were slightly better, with total orders from -7 to -2 and selling prices from +57 to +59.
Public finances: public finances worsened ahead of the Chancellor’s mini-budget, with the Public Sector Net Borrowing Requirement rising from £2.9bn to £11.1bn in August.
No relief for surveys
Surveys: the eurozone consumer confidence fell from -25 to -28.8. The S&P Global Eurozone Manufacturing PMI dropped from 49.6 to 48.5 and services PMI from 49.8 to 48.9.
Japanese surveys remarkably resilient
China: no meaningful statistics during the week.
Japan: the Jibun Bank Services PMI improved from 49.5 to 51.9 and the manufacturing PMI was a little lower at 51.0 vs. 51.5.
Oil prices collapsed last week on weaker global economic expectations. All commodities fell as the US dollar surged against developed currencies by more than 3%. Brent oil fell 6.4%, copper 4% and gold almost 2%.