Markets last week

Last week was dominated by a Chinese real estate crisis, with the looming default of Chinese property giant Evergrande. Markets reacted sharply early in the week to the news of the company missing an interest payment, although they later met other obligations. Chinese authorities were noticeably absent during the height of the turmoil, apparently willing to let the markets ’do their worst‘. In fact, it does look like the authorities moved fast to ring-fence the firm to avoid a full-blown market panic, adding liquidity to the markets. The phrase ’keyhole surgery‘ was used to describe their intervention, aiming to punish the perpetrators of bad economic deeds whilst preserving the soundness of the financial system and the underlying building projects. To place the Evergrande problems in the right context, the company’s US$300bn of debt should be compared to total Chinese bank loans of approximately US$30trn. Although the analogy to Lehman Brothers was repeated across markets, the situation is definitely not comparable.

Markets performed a roundtrip on risk during the week, being hard hit on the Evergrande news and later recovering, although not all markets behaved similarly. At the end of the week, the best returns came from US, European and UK large capitalisation shares and the worst from Chinese-related markets. The leading sectors were pro-cyclical, energy and financials, whereas the lagging ones were defensive, utilities, real estate, consumer staples and healthcare.

The week also saw momentous meetings of the US Federal Reserve (Fed) and the Bank of England (BoE). As usual, statements were analysed to death, but the Fed did not make any announcements, only confirming that tapering asset purchases was much closer and the BoE did not change its purchases either, despite a 7-2 vote as opposed to unanimity. The BoE must have felt the uncertainty that is gripping the UK economy amid supply chain problems, some hitting consumers, but also the end of the furlough scheme and no clarity as to how many employees would be returning full-time to their jobs.

Government bond yields surged on the expectation of tapering and an economic recovery after a soft patch. Oil prices rose sharply and the US dollar continued its strong run.

Among the swarm of regulations coming out of China, it decreed that crypto-related transactions are now illegal in the country.

The German elections yesterday were too tight to warrant any significant move in markets and augur a long time ahead in negotiations to form a governing coalition.

The week ahead

Wednesday: China CFLP (China Federation of Logistics and Purchasing) manufacturing and non-manufacturing PMIs and Caixin manufacturing PMI

Our thoughts: many Chinese sectors have been in turmoil recently, due to the regulatory onslaught. The Evergrande default situation may well have taken a toll on economic growth in the country, or at least on the property area. Given that the PMIs have been reducing in the last few months, with the non-manufacturing PMI even falling below 50, it will matter to markets whether the situation improves or deteriorates. The estimates show a rally in the non-manufacturing PMI and a stable manufacturing PMI. It may be too early for recent market worries to be reflected in surveys, but the readings are liable to move investors’ expectations.

Friday: US PCE deflator and PCE core deflator

Our thoughts: inflation is being driven by supply chain issues, bottlenecks and employment mismatches across the world, with the US very much in the eye of the storm, as imports from China are facing soaring freight rates and shipping queues outside US ports. These unusual costs have been added to reopening issues affecting the travel and hospitality, leisure and high street retail sectors. The big question is still whether the price rises, described as ‘transitory’ by central banks, are spreading to other parts of the economy. The core PCE (personal consumption expenditures) deflator is the inflation gauge followed by the Fed, not the more popular CPI (consumer price index). Currently the market is expecting a small downtick in both the PCE and core PCE (ex food and energy). Whether this is met by the data is only part of the question. Which prices are rising compared to previous months is more important, as it will address the issue of potentially spreading inflation.

Friday: ISM manufacturing PMI

Our thoughts: the ISM (Institute for Supply Management) is always a treasure trove of information about how the US economy is faring. Beyond the headline readings, the details are revealing as to which issues work, don’t work and matter for businesses in the US. The important sub-categories will be prices paid (as a harbinger of inflation changes), new orders (as a growth proxy), customer inventories (forecasting pent-up demand), employment and others. If the PCE inflation number does indeed show a downtick, would this be confirmed by the ISM? If the Atlanta Fed is still expecting 3.6% GDP growth in the middle of the worst supply chain problems, is that confirmed by the new orders on the books of contributors to the ISM survey? The survey could help dispel stagflationary fears or maybe heighten them.

Markets for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

The Fed and the BoE dominated the airwaves but did they announce anything new?

The FOMC (Federal Open Markets Committee) of the Fed met and announced no changes in rates or quantitative easing (QE) but the statement strongly foreshadowed a QE taper, saying “if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” It was a unanimous vote meaning it’s likely to be announced at the November meeting. The QE taper could be finished by the middle of next year.

Much has been made of the fact that half of the Fed members are forecasting a rate hike next year (in the so-called ’dot plots‘), but (1) dot plots have a very poor track record of projecting real rate changes, (2) many of today’s Fed members won’t be there then, (3) Chair Jay Powell has super voting power or, if he is replaced, it would be by someone who is even more dovish like Lael Brainard and (4) next year could mean December, i.e. 15 months away. After digesting all of this, bond markets sold off and equities resumed their buoyant pre-Evergrande mood.

The Fed’s GDP forecast for 2021 came down from 7% to 5.9%. They expect inflation to revert back to 2.3% in 2022, 2.2% in 2023 and unemployment to be 3.8% by end 2022 and 3.5% by end 2023.

The BoE voted unanimously to keep rates at a record low 0.1%. Moreover, the BoE voted 7-2 to maintain its asset purchase programme at £895bn. They did however signal that higher inflation and slower growth were ahead and lowered their Q3 2021 GDP forecast to 2.1% versus 2.9% in August.

The BoE statement said: “the pace of recovery in global activity has shown signs of slowing. Against a backdrop of robust goods demand and continuing supply constraints, global inflationary pressures have remained strong and there are some signs that cost pressures may prove persistent.”

The Bank of Japan left policy rates, the 10-year yield target and asset purchases unchanged.

Lastly, the People’s Bank of China added cash into the financial system amid concerns that contagion from Evergrande could affect market liquidity. It injected a net US$71bn of short-term cash into the banking system in the past week.

United States

Housing sector still buoyant even with slower surveys

Housing: the NAHB housing market index edged up from 75 to 76 in September. Housing starts rose 3.9% in August, up 17.4% year-on-year, while building permits increased 6% and 13.5% year-on-year, both much stronger than the previous month. Existing home sales, however, fell 2%. MBA mortgage applications increased 4.9% for the week. New home sales rose 1.5% in August compared to an upwardly-revised 6.4% the previous month.

Surveys: the Markit manufacturing PMI was a tad lower at 60.5 vs. 61.1 and the services PMI also at 54.4 vs. 55.1. The Chicago Fed National Activity Index fell 0.46 to +0.29, driven by production and income, employment and sales. The Kansas City Fed manufacturing activity index fell from 29 to 22.

Employment: initial jobless claims rose for the second week, from 335K to 351K with continuing claims also higher at 2845K vs. 2714K. The 4-week average is much lower, though.

United Kingdom

Some surveys are falling sharply

Public finances: UK public finances saw a big improvement in August. Government borrowing was 25% below expectations between April and August, at £93.8bn vs. £125.7bn expected.

Surveys: the CBI trends data for September were relatively flat, with total orders rising from 18 to 22 but selling prices easing from 43 to 41. The CBI retailing survey was very disappointing, with reported sales collapsing from 60 to 11 and total distribution reported sales slumping from 45 to 21.

The Markit/CIPS services PMI dropped to 54.6 from 55 while the Markit manufacturing PMI declined to 56.3 from 60.3 in August, below estimates. With the survey also pointing to sharp price rises in September, it appears supply constraints are currently the dominant force.

GfK consumer confidence fell at its sharpest pace since October 2020, reflecting a surge in inflation and looming tax increases. The survey dropped 5 points from -8 to -13.

Europe

Europe starts to feel the chill from other regions

Surveys: eurozone consumer confidence improved marginally from -5.3 to -4.0. The eurozone manufacturing PMI slipped from 61.4 to 58.7 with Germany from 62.6 to 58.5 and France from 57.5 to 55.2 and services PMI from 59.0 to 56.3. Germany and France both fell in line with the eurozone for manufacturing, but France was more resilient on services.

Separately business confidence improved a smidge in France from 110 to 111, but manufacturing confidence was lower at 106 vs. 110 and the production outlook indicator rose from 16 to 23.

The German IFO survey fell to the lowest level since April, with expectations easing from 97.8 to 97.3, the current assessment down from 101.4 to 100.4 and the business climate from 99.6 to 98.8.

China/India/Japan/Asia

Japan cannot get any inflation, regardless of other factors

China: no meaningful data announced

Japan: the national CPI (consumer price index) fell to -0.4% in August from an already negative -0.3% the previous month. Core inflation, i.e. the national CPI ex fresh food and energy, improved very marginally from -0.6% to -0.5%.

The Jibun Bank manufacturing PMI fell a little from 52.7 to 51.2 but the services PMI bucked the global trend by rising from 42.9 to 47.4, which is still below the threshold between expansion and contraction.

Oil/Commodities/Emerging Markets

Oil has been well supported throughout the week, rising 3% on average, thanks to the output discipline. Industrial metals were less buoyant, reflecting concerns about Chinese growth.