Markets last week
Last week, markets relied more on economic data than central bank communication. Better purchasing manager indices (PMI) across the world, especially in services, initially supported investor sentiment, as the services improvements were broad-based (UK, eurozone, Japan, US). This was not unmitigated good news, however, since stronger services activity means more inflation in an employment-constrained economy.
Regionally, the eurozone displayed sticky inflation, the UK posted better surveys and public finances, China enjoyed a massive increase in inbound foreign investment and Japan experienced the highest inflation rate in 41 years. In the US, data were generally strong. On Friday, the Personal Consumption Expenditures (PCE) inflation surged above expectations, spooking investors in all asset classes. Indeed, the core PCE gauge is the one used by the US Federal Reserve (Fed) for their 2% inflation target and it rose from 4.4% (revised upwards) to 4.7% in January, a shock to markets which have been used to the concept since the middle of last year that we have already seen the inflation peak and are now relentlessly moving downward.
This brought forth the realisation that the US economy is so strong that it will need higher rates for longer than anticipated to get inflation down, a headwind for many assets, although the counter-argument is that central banks may not necessarily want to create deep recessions to get price rises to an artificially selected 2% target.
Once again, movements in bonds seemed to be ahead of those in equities. Government bond yields rose sharply, trying to catch up with futures on US Federal funds rates, which show three additional rate hikes expected in the next few months, and with US inflation breakevens (prediction of future inflation). Indeed, the 2-year breakeven now exceeds 3% (up from slightly above 2% in early January). Against that backdrop, global equities increasingly reacted to future rates by the Fed, which challenged certain interest rate-sensitive sectors. The risk-off mood was echoed by the US dollar recovery.
Also, with most US companies and a majority of European companies having reported their earnings for Q4 2022, the top line has been performing better than the bottom line, which seems to foreshadow an erosion in profit margins.
At the end of the week, equities suffered their third down week, losing 2.6% globally in US dollars, although the dollar was up 1% in trade-weighted terms. European and Hong Kong shares did worst, and Japan was the most resilient. There was little hiding place in sectors, with energy and consumer staples falling the least, a reminder of last year’s favoured sectors. Once again, 2-year US treasury yields hit a 16 -year high, now above 4.8%. Longer maturity bond yields rose across the board in double-digit basis points. The US dollar strength crimped commodity returns but oil prices were solid, supporting energy equities.
The week ahead
Tuesday: China PMIs
Our thoughts: somehow, markets seem to have forgotten how abrupt the move was from lockdown to full reopening in China. It is not, however, simply a matter of turning on the spigots and the economy goes back to normal after nearly three years of constrained activity. We need to understand how the Chinese consumer behaves, whether the property sector is still challenged, whether infrastructure spending or other capital expenditures move the dial on growth and whether optimism is returning to the country. The PMIs answer many of these questions, with perhaps less detail than in the west, but the difference between the manufacturing and non-manufacturing PMIs will be crucial. Historically, Chinese PMIs have seen relatively little volatility month-over-month, but the recent moves have been large. Will this trend continue?
Tuesday: US Conference Board consumer confidence
Our thoughts: we have a plethora of US surveys to pick from to understand what is going on in the economy, but the current cycle is unusual, having started from a natural disaster to which governments replied with a sledgehammer of fiscal stimulus. The question is whether some of the traditional guides to the cycle are still indicative of the future economic path. Yield curves, bank lending, housing trends, PMIs are some of the standard indicators. The recent strength of the US economy raises the question of how resilient the consumer can be, as the last bulwark against a potential recession ahead. The Conference Board consumer confidence survey has generally been the most accurate bellwether of consumer behaviour in the US, notably the expectations component and its peaks and troughs have coincided with market inflection points. Right now, the survey is stuck halfway between the COVID-19 low and post-COVID-19 high. The next few moves could be meaningful.
Thursday and Friday: eurozone CPI and PPI
Our thoughts: how fast (and reliably) inflation is coming down in the main regions of the world is the biggest question for markets right now. The eurozone numbers are no exception. It is well known that the spike in inflation has been heavily influenced by energy costs in the area, but now that they have come down, can we see a path to a reasonable inflation level? The consumer price index (CPI) to be published on Thursday is expected to fall but could still remain in high single digits for some time. The core CPI is anticipated to remain unchanged, which would point out to the drop in inflation being driven by energy alone, with other costs staying high. On Friday, the producer price index (PPI) will show whether input pressures are falling faster than output, which would be good news.
The numbers for the week
Central banks/fiscal policy
Not much new in central bank communications, but future Bank of Japan (BoJ) Governor talks about being “creative” in monetary policy
The minutes from the Fed meeting on 31 Jan-1 Feb were published. Almost all Fed officials agreed on 25 bp hiking clip while a few were going for 50 bps. After the minutes, Fed fund futures rose to a peak of 5.37%, which forecasts another three 25 bp hikes ahead. Other markets were relatively unchanged.
St. Louis Fed President James Bullard said the strong, resilient US economy requires more rate hikes, as high as 5.375%. New York Fed President John Williams reiterated the 2% inflation target. “At the end of the day our job is clear…Our job is to make sure that we restore price stability which is truly the foundation of a strong economy.”
As a response to the high PCE print, Cleveland Fed President Loretta Mester said she saw rates rising “somewhat” about 5%. “We’re going to have to do a little more to get back to price stability of 2%.”
German Bundesbank President Joachim Nagel, a senior official of the European Central Bank (ECB), suggested that the ECB may have to keep providing high interest rate increases. “I expect a robust rate increase in March… and I don’t exclude that further significant rate hikes may be needed beyond March.”
Future BoJ Governor Kazuo Ueda stressed continuity, by saying that the BoJ should continue its easing policy to get to the 2% inflation target but added that the BoJ should be “creative” in its monetary policy. “… in light of the economic and price conditions, the methods have been necessary as well as appropriate to sustainably achieve the 2% inflation target.”
Against the backdrop of a strong economy and tight jobs market, the PCE inflation number was way above expectations and must worry the Fed
Surveys: the Philadelphia Fed Non-Manufacturing Activity index bounced back from -6.5 to +3.2, the Chicago Fed National Activity index rose from -0.46 to +0.23, the Kansas City Fed Manufacturing Activity index edged up from -1 to 0 and the Kansas City Fed Services Activity index also moved up from -11 to +1.
The S&P Global PMIs were stronger, with the manufacturing PMI from 46.9 to 47.8 and the services PMI from 46.8 to 50.5.
Housing: the Mortgage Bankers Association (MBA) mortgage applications series fell 13.3% for the week, down from -7.7% previously. Existing home sales were down 0.7% in January, after -2.2% the prior month. New home sales bucked the negative housing market trend, with 7.2% growth this month following +7.2% previously.
Employment: jobless claims remained very low, with initial claims actually falling from 195K to 192K and continuing claims down from 1691K to 1654K.
Inflation: the PCE index was higher than expected, with the PCE deflator rising from 5.3% to 5.4% and core PCE (which is the Fed’s inflation gauge with a 2% target) up from 4.6% to 4.7%. Both previous numbers had been revised upwards. Most of the additional inflation came from services prices excluding housing (so-called ‘super-core inflation’), which rose 0.58% during the month and 4.61% year-on-year.
Consumer: personal income rose 0.6% in January, from 0.3% the prior month, with personal spending up a strong 1.8%, up from -0.3%.
Has the UK economy finally turned the corner? Surveys and public finances improve
Public finances: there was a significant improvement in public finances announced. The Public Sector Net Borrowing Requirement (PSNBR) flipped from a £24.8 bn borrowing in December to a surplus of £6.2 bn in January.
Surveys: the PMIs improved. The S&P Global/CIPS manufacturing PMI rose from 47.0 to 49.2 but the services PMI did particularly well, up from 48.7 to 53.3.
Confederation of British Industry (CBI) surveys were generally better. The CBI Trends totals orders edged up from -17 to -16, with the selling prices a little lower at 40 vs. 41. The CBI retailing reported sales bounced back from -23 to +2 with the total distribution reported sales up from -22 to -12.
The GfK consumer confidence survey improved from -45 to -38, above estimates.
Continued improvement in economic surveys but sticky inflation
Surveys: eurozone consumer confidence improved marginally from -20.7 to -19.0. The ZEW (Zentrum für Europäische Wirtschaftsforschung) survey expectations for the eurozone jumped from 16.7 to 29.7. In Germany, ZEW expectations surged from 16.9 to 28.1 and the current situation improved from -58.6 to -45.1.
The German IFO (Institut für Wirtschaftsforschung) business climate survey rose from 90.1 to 91.1, the IFO current assessment from 94.1 to 93.9 and the IFO expectations from 86.4 to 88.5. The German GfK consumer confidence survey improved from -33.8 to -30.5.
French business confidence was better at 103 vs. 102, with manufacturing confidence also up to 104 from 103 and the production outlook indicator from -8 to 0. French consumer confidence moved to 82, from a previous 80 revised to 83.
The S&P Global PMIs were mixed, with manufacturing slightly off at 48.5 vs. 48.8, but services stronger at 53.0 vs. 50.8.
Industry: EU27 new car registrations eased from 12.8% year-on-year to 11.3% in January. Construction output in the eurozone was down 2.5% in December after -0.1% the prior month.
Inflation: inflation was sticky, with the eurozone CPI actually rising from 8.5% to 8.6% and the core CPI up from 5.2% to 5.3%
Surprising strength in foreign investment into China and shocking high inflation in Japan
China: foreign direct investment into China rose 14.5% in January year-on-year vs. 6.3% the previous month.
Japan: the Jibun Bank PMIs were mixed, with manufacturing down from 48.9 to 47.4 and services up from 52.3 to 53.6. The PPI for services was up from 1.5% to 1.6%. The national CPI rose from 4.0% to 4.3%, a 41-year high, with the CPI ex fresh food and energy also up from 3.0% to 3.2%, slightly below estimates.
Most commodities were still a little softer last week in line with a stronger US dollar. The anniversary of the Ukraine invasion by Russia did not have a meaningful impact on energy prices, but crude was the most resilient commodity in light of the dollar recovery.