Markets last week

Risk markets capped the last full week of the second quarter with an uptick. Equities rose globally, government bond yields resumed their ascent and commodity prices were sustained. Many commentators have been pointing at a possible peak in economic growth during Q2, which is starting to be noticeable in some statistics in the US and the UK. The eurozone, though, after a negative Q1, has picked up strength across the board in Q2. Chinese data were not available during the week, but we should watch carefully this week for signs of cresting growth there, too.

Central banks reiterated their full-throated support of monetary accommodation without concern for the current spikes in inflation. Both the US Federal Reserve (Fed) and Bank of England were steadfast in their belief that price pressures are transitory.

The US political machine moved up one gear, as a bipartisan infrastructure spending proposal was agreed between moderate Republicans and Democrats, with President Biden’s nod of assent. The amount, though, is only US$579bn of new money (higher headline numbers in the press include existing projects), as opposed to the US$2.2trn originally billed. Its passage through Congress is not guaranteed but the fact that members of both parties have been working on it for months, bodes well for its eventual approval. The announcement helped power another movement towards value shares after a couple of months where the growth-to-value rotation stalled.

Inflation numbers are still very high in the US, but longer-term price movements may well be determined by demographic trends. In the UK, last year there were more deaths than births for the first time since 1976. In the US, births fell by 4% in 2020, the largest decline since 1973, with an acceleration in the drop during the second half of the year. COVID-19 has not been kind to population growth, which may well have some longer-term impact on the global economy.

The Fed gave the largest 23 banks in the US a stress test which they all passed and as a result they have more freedom to pay dividends and execute buybacks. This helped returns for financials last week.

At the end of the week, equities rose almost 2%, with the US and UK at the top of the league and Japan lagging. The strongest sectors were energy and financials. The US dollar took a breather from its recent rally whilst government bond yields were higher across the board, in particular in the US. Copper and oil resumed their climb. 

The week ahead

Tuesday and Wednesday: China manufacturing and non-manufacturing PMI + Caixin PMI manufacturing

Our thoughts: Chinese PMIs are often followed closely not for their accuracy, but for their directionality, even though the movements are sometimes quite small. The Caixin manufacturing PMI is sometimes expected to correlate with US GDP growth with a lead time. The standard CFLP (China Federation of Logistics & Purchasing) PMI tends to be more stable than the Caixin and hence give less clues on direction. It does, however, show the relationship between manufacturing and non-manufacturing quite vividly. China has been trying to rebalance its economy away from infrastructure spending and industrial exports more towards domestic consumer spending, which would be highlighted by the non-manufacturing reading. The Chinese PMIs can therefore show us whether global growth is peaking (a comment often made these days) and whether global trade is softening if manufacturing is transitioning to non-manufacturing.

Thursday: US ISM manufacturing PMI

Our thoughts: the ISM (Institute for Supply Management) provides a very detailed PMI breakdown. Prices paid, new orders and employment are among the main categories, but it is also possible to see the trend within orders by comparing them to inventory growth. The headline PMI peaked in March and since then has shown exceptionally high prices paid and challenged employment levels. The Fed will obviously be watching very carefully for these two components which point towards the potential achievement of their basic objectives. It will also show how the pipeline is being filled, how many orders are not being met and carried over to the next period and how the backlogs are moving.

Friday: US employment data

Our thoughts: market forecasts of employment data in the US seem to show the triumph of hope vs. experience. The last two months have bitterly disappointed market watchers. A total of 1.6 million new jobs were expected to be created vs. an outturn of only 837K. Markets are still projecting a higher number of 700K for June, against the backdrop of higher jobless claims than estimated. The labour force participation rate, which has been very low recently, could point towards some employment market healing. The unemployment (U-3) and underemployment (U-6) rates will be watched but won’t move markets as much as the components of the headline payrolls number (private vs. public payrolls, positive and negative sectors). One additional area of focus will be the average hourly earnings which would feed into the inflation analysis!

The numbers for the week

Sources: FTSE, Canaccord Genuity Wealth Management

Central banks/fiscal policy

Fed and BoE steady on inflation and monetary policy. An infrastructure deal in the US?

US Federal Reserve (Fed) Chair Jerome Powell said inflation had picked up but should move back toward the central bank’s 2% target once supply imbalances resolve. “A pretty substantial part, or perhaps all of the overshoot in inflation comes from categories that are directly affected by the re-opening of the economy such as used cars and trucks. Those are things that we would look to stop going up and ultimately to start to decline. I will say that these effects have been larger than we expected and they may turn out to be more persistent than we expected.”

John Williams, President of the New York Fed, said he expects bottlenecks and imbalances produced by a strong recovery to subside, bringing inflation down to around 2% next year and in 2023. James Bullard, St Louis Fed President and Robert Kaplan, Dallas Fed President, however, disagreed and suggested an early start to tapering.

A group of moderate Republicans and Democrats in the US Congress have agreed a US$579bn infrastructure spending bill with a nod from President Biden. This is a much smaller amount than the original US$2.2trn proposal and still has to work its way through Congress. It could be followed by a larger spending package later on in order to get closer to the total amount desired by Biden.

In the UK, the MPC (Monetary Policy Committee) kept the Bank Rate unchanged at 0.10%. The MPC also voted 8-1 to maintain its target for the stock of government bond purchases at £875bn.

Most MPC members think above-target consumer price inflation will be temporary. Their forecasts, however, have risen to above 3% (up from 2.5% last month) for the end of this year. They also now expect growth to rise to 5.5% in Q2, vs. 4.3% last month. Concerns about the ending of the furlough programme have been weighing on inflation expectations and monetary policy.

The Bank of England’s Chief Economist Andy Haldane, who has voted to reduce the pace of stimulus, is stepping off the MPC and the question is whether he will be replaced by a dove or hawk, as he is the most hawkish member right now.

United States

High inflation is not surprising markets any longer. Most other data show a peak at a high level

Inflation: the PCE (personal consumption expenditures) inflation gauge rose from 3.6% to 3.9%, with the core PCE deflator increasing from 3.1% to 3.4% (a 30-year high), in line with estimates. Used car prices at auction rose 0.3% in the first two weeks of this month, a slowdown from the 5.7% average increases in the previous four months (used car prices were the largest factor in the increase in US CPI recently). Within the University of Michigan Sentiment survey, the 1-year inflation expectations rose from 4.0% to 4.2% whereas 5-10-year inflation remained at 2.8%.

Personal income fell 2% in May, slightly less than expected and personal spending was flat, down from +0.9% the previous month.

Housing: existing home sales fell to 5.80M in May from 5.85M, the fourth straight fall in sales. New home sales fell to 769K from 863K, well below estimates. Inventory is starting to rise, but house prices are continuing their rapid ascent. The housing market has nevertheless rolled over in the US, although the reason is not clear: high prices, lower mortgage availability or saturated demand for moving from the city to the suburbs.

Industry and Trade: durable goods orders rose 2.3% in May, below estimates. Orders ex-transportation rose 0.3%, also below expectations. Both are disappointing readings, but there are positive revisions to previous numbers and the underlying trend in core orders is still rising strongly. The goods trade deficit rose to US$88.1bn from US$85.7bn.  

Employment: initial jobless claims fell to 411K from 418K, worse than expected. It looks like claims are not moving much from this level, but continuing claims have fallen further from 3534K to 3390K.

Surveys: the Kansas City Fed Manufacturing Activity index rose marginally from 26 to 27, above estimates. The bellwether University of Michigan Sentiment Index unexpectedly eased from 86.4 to 85.5 with the current conditions being mostly responsible for the drop vs. the expectations component.

United Kingdom

Positive details below headlines of peaking economic data

Housing: house price growth slowed in June, as per Rightmove. Prices grew 0.8% this month after a 1.8% gain the month before, putting the average cost of a home at £336,073. The increase is still the largest at this time of year since 2015, boosted by people seeking to leave London.

Sales: the CBI sales series was better than expected. Reported sales rose from 18 to 25 in June with total distribution reported sales slightly easier at 40 vs. 43.

Public Finances: public sector net borrowing excluding public sector banks was £24.3bn in May, below expectations. The estimate of borrowing in April was revised down to £29.1bn, from £31.7bn previously. Public borrowing is continuing to decline more rapidly than the OBR expected, undershooting its £28.5bn forecast by £4.2bn, due to stronger-than-expected central government receipts, as more people return to work.

Surveys: in the CBI industrial trends survey the total orders balance rose to +19 in June, from +17 in May. The further jump in the total orders balance to a new high suggests that there is still strong demand for manufactured goods. While the export orders balance rose to its highest level in two years, a majority of manufacturers still reported that orders were “lower than normal”, despite surging global goods demand.

The Markit/CIPS services PMI was almost unchanged at 61.7, from 61.8. The Markit/CIPS manufacturing PMI fell to 64.2, from 65.6. The survey confirms UK manufacturers’ export woes, with the export orders balance of the UK survey undershooting the eurozone’s for the sixth consecutive month. Businesses still are hiring rapidly as they reopen, although some may simply be bringing people back from furlough. The composite employment index jumped to a record high of 58.5 in June, from 57.4 in May. The further rise in the composite output price index from 59.3 to 60.5 in June brought it to the highest level in 23 years.

Health: the UK reported 16,135 new cases of COBID-19, the biggest daily increase since 6 Feb. The UK has now given three in five adults both doses of the COVID-19 vaccine, but the recent studies show that the Astra-Zeneca vaccine does not protect well against the Delta variant which is now dominant in the UK and may require a third jab.

Europe

Stronger surveys throughout point to an exceptional upswing in Q2 after a depressed Q1

Surveys: the consumer confidence index in the eurozone rose to -3.3 in June, from -5.1 in May, taking it to a 41-month high. For the eurozone, the Markit manufacturing PMI was unchanged at 63.1 whereas the Markit services PMI jumped from 55.2 to 58.0. The PMIs were stronger in Germany but weaker in France.

The IFO business climate index in Germany rose to 101.8 in June, from 99.2 in May, beating estimates and closing at its highest level since 2018. The current assessment index jumped, to 99.6 from 95.7 last month and is now above its pre-COVID-19 level. The expectations index surged to 104.0 from 102.9, its highest in just over a decade.

In France, the manufacturing sentiment index was unchanged at 107 in June. The aggregate business confidence index leapt to 113 from 108. The services component also climbed to 113 from 107. Sentiment among retail firms surged to a 40-month high of 115. The employment climate index improved sharply too, rising to 104 from 99.

Money Supply: eurozone M3 money supply fell from 9.2% to 8.4% year-on-year.

China/India/Japan/Asia

China: Chinese industrial profits are peaking, up 36.4% year-on-year in May vs. 57% the previous month.

Japan: the Leading Index CI rose from 103.0 to 103.8 whereas the Coincident Index eased from 95.5 to 95.3.

Oil/Commodities/Emerging Markets

Oil and copper resumed their upward trend after correcting over the previous weeks. The Chinese government’s drive to stem the rise of commodity prices by selling from its strategic reserves may have been less prominent last week.

Against the backdrop of stronger risk appetite and higher bond yields, gold prices were nevertheless supported.