Markets last week
Policy was back on the front page last week, with a speech by US Federal Reserve (Fed) Chair Jay Powell moving markets and the UK Chancellor of the Exchequer’s spring budget having an impact on UK sentiment if not necessarily the markets.
Shortly after the last Fed meeting the previous week, Fed Chair Powell delivered an additional speech with more hawkish details about future rate policy. The focus was on potential 50 bp hikes and the word “expeditiously” was used profusely to indicate hurry in getting inflation down. Markets did not take long to react abruptly to the new comments, with US treasury rates rising, a flattening of the yield curve (i.e. short-term rates rising faster than long-term rates) and soaring inflation expectations.
US government bonds dragged other world government bonds down, with gilts and eurozone bond yields rising in sympathy. The urgency expressed by the Fed Chair is reflected in the markets through the odds of a 50 bp hike in May rising above 2/3 and eight expected rate increases this year, but also in the concern that the Fed might raise rates too far, too fast and might have to reduce them in late 2023 and 2024. US inflation expectations have also surged, with the five-year rate at 3.73%, up from 2.80% a month ago, and the 10-year rate at 2.98%, up from 2.40% a month ago.
In the UK, the measures announced by the Chancellor of the Exchequer to dampen rising costs for households were very much in line with expectations and hence did not move markets. In practice, this is a modest net fiscal loosening equivalent to 0.30% of GDP in 2022, whilst interest rates are poised to go up at the same time. The market is pricing the bank rate rising by a further 1.25% by year-end to 2%.
Against that policy move backdrop, economic data did not really register. The monthly PMIs were quite benign, with Japan improving, the US apparently unaffected by Ukraine so far, the UK starting to show some manufacturing problems and Europe looking the most vulnerable, as four of the five sub-components of the PMIs are much weaker, despite the headline looking fairly stable.
Some relief for beleaguered European energy consumers came from the announcement from President Biden and European Commission President Ursula von der Leyen that they agreed on additional exports of US LNG (liquid natural gas) to the EU to cut dependence on Russian gas.
Markets were generally more sanguine last week. At the end of the week, government bond yields surged again, rising 20 bps in the UK and eurozone but a massive 32 bps for the US 10-year treasury yield, now near 2.5%. Oil prices were back close to their highs this year, with Brent up 12%. Equities had a benign week with US markets at the top and Europe at the bottom. Japanese equities were also buoyant, benefiting from a sharp fall in the yen which helps exporters. The best sector was once again energy, up more than 7% globally, with materials in tow. Healthcare was one of the few down sectors.
The week ahead
Wednesday: China official manufacturing and non-manufacturing PMIs, plus Caixin manufacturing PMI
Our thoughts: the Chinese economy is buffeted by many winds: high energy and commodity prices, a slower global growth backdrop and their own property developer crisis. On the other hand, fiscal and monetary policies have been adding a moderate amount of stimulus, through small cuts in interest rates (unlike the rest of the world) and more spending for local authorities. How much of this situation will be reflected in the normally slow-moving Chinese PMIs?
Thursday: US PCE deflator and core deflator
Our thoughts: inflation is once again the dominant topic and the core PCE (personal consumption expenditures) is the US Federal Reserve’s own inflation gauge, with a target of 2%. The current expectation is for the core reading to reach 5.5% and the headline PCE (including food and energy) 6.4%. These are higher levels than the previous month and show no sign of peaking at this stage. Any outliers compared to the estimates have the potential to move markets, since they could change the pre-determined path the Fed has laid out for future interest rates.
Friday: US employment data for March, plus ISM manufacturing PMI
Our thoughts: the US job market still appears to be red-hot, with jobless claims at a record low for 50 years. The question on Friday will be how many new jobs have been created in March and whether any other employment numbers are moving decisively (unemployment and underemployment rates, average hourly earnings, labour force participation rate). Also, the sectoral breakdown of the new jobs will give a picture of how much the US is moving from goods consumption to services.
In addition, the ISM (Institute for Supply Management) manufacturing PMI will be published 15 minutes later, so markets will have a lot to digest. With the ISM, the absolute level matters less (unless there is a big change) than the details (new orders, employment, prices paid, inventories, backlogs, etc.).
Markets for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Fed Chair sounding more hawkish and UK Chancellor trying to help
Fed Chair Jerome Powell said the Fed will take the “necessary steps” to get inflation down even if that means increasing interest rates more rapidly than currently anticipated. “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so. And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.” He said central banks typically look through event-driven commodity price shocks, but this time won’t necessarily be typical. “The risk is rising that an extended period of high inflation could push longer-term expectations uncomfortably higher, which underscores the need for the committee to move expeditiously as I have described. This underscores the need for the Committee to move expeditiously.” Expeditiously is the latest buzzword.
Powell said that action to reduce the balance sheet “could come as soon as our next meeting in May, though that is not a decision that we have made.” He said they are looking for “actual progress” on inflation to guide interest rate decisions. “Soft, or at least soft-ish, landings have been relatively common in US monetary history. I hasten to add that no one expects that bringing about a soft landing will be straightforward in the current context—very little is straightforward in the current context. By many measures, the labour market is extremely tight, significantly tighter than the very strong job market just before the pandemic.” There were three such “soft landings” when hiking cycles did not result in recessions: in 1965, 1984 and the last one was in 1994.
Chicago Fed President Charles Evans, who is not a voting member, said he’s “comfortable” with raising interest rates by 25 bp increments, while being “open” to a bigger 50 bp move if needed. “We want to be careful, we want to be humble and nimble, and get to neutral before too long. My own viewpoint is in line with the median assessment, seven 25 bp hikes in 2022, with the policy rate moving up to 2.75% to 3% by the end of next year.” Evans drew a distinction between the high inflation of the 1980s and that of today. While “overly accommodative monetary policy” in the 1960s and 1970s contributed to a build-up of long-term inflation expectations, the current surge in prices “largely reflects real supply shocks and weakened supply chains and logistics in the face of strong, outsized demand for goods and diminished labour force participation.”
UK Chancellor Rishi Sunak delivered a £6bn personal tax cut for 30 million people in the UK (with an increase in thresholds, a cut in fuel duty and a future reduction in income tax) against the backdrop of prices rising at the fastest pace in three decades and further costs set to bite next month when a cap on domestic energy bills rises by 54% and a new 1.25% payroll tax comes in.
Sunak said the conflict in Ukraine poses a risk to the economic recovery as the OBR (Office for Budget Responsibility) downgraded its 2022 growth forecast to 3.8% from a previous estimate of 6%, to 1.8% in 2023 and 2.1% in 2024, from estimates of 2.1% and 1.3% in October (actually an increase in 2024). Inflation will average 7.4% this year. Borrowing over the next fiscal year is now forecast to be £99bn, £16bn higher than previously predicted, with debt interest costs hitting a record £83bn.
Surveys holding firm, jobless claims at low, but housing starting to fade
Surveys: the Chicago Fed National Activity Index was softer at 0.51 vs. 0.59. The Richmond Fed Manufacturing Index surged from 1 to 13. Among the details, we note reduced vendor lead time, improving raw material inventories and a reduced expected orders backlog. The Kansas City Fed Manufacturing Activity Index rose sharply from 29 to 37. The US S&P Global PMIs (formerly known as Markit) were much better than estimates, with manufacturing up from 57.3 to 58.5 and services up from 56.5 to 58.9. The bellwether University of Michigan Sentiment Survey was little changed, at 59.4 vs. 59.7 last month, with current conditions down from 67.8 to 67.2 and expectations a smidge lower at 54.3 vs. 54.4.
Inflation: inflation expectations embedded within the University of Michigan Sentiment Survey were unchanged, at 5.4% for one-year inflation and 3% for 5-10-year inflation.
Housing: the US housing market is starting to show signs of fatigue. MBA mortgage applications have been falling for a few weeks now, down 8.1% over last week as higher mortgage rates and higher prices start to kick in. US mortgage rates surged to 4.42%, the highest since January 2019.
New home sales were also down 2% in February, following an 8.4% drop. Pending home sales fell 4.1% in February for a -5.4% year-on-year move, better than
the -9.2% the previous month.
Employment: initial jobless claims fell to the lowest since 1969, decreasing by 28,000 to 187,000, way below estimates. Continuing claims dropped to 1.35 million, the lowest since 1970.
Industry: US durable goods orders fell 2.2% in February with a drop in transportation, though this series is volatile. It is worth noting that non-defence capital goods shipments ex aircraft rose 0.5%.
30-year inflation record amid mixed economic data and weaker surveys
Inflation: the CPI (consumer price index) rose 0.8% in February to a 30-year high of 6.2% year-on-year, up from 5.5% and above estimates. Unsurprisingly the biggest increases came from gas, electricity and auto fuel, but many other products are services were also surging.
The PPI (producer price index) input rose to 14.7%, the highest since records began in 1997, and the PPI output to 10.1%. CPI is expected to rise mechanically over the next two months, due to the energy price cap and hospitality VAT back at 20%.
Housing: the January house price index (average price for all dwellings published by the UK Land Registry) eased a little from 10% year-on-year to 9.6% in January.
Surveys: the manufacturing PMI fell from 58.0 to 55.5, below estimates, but the services PMI unexpectedly edged up from 60.5 to 61.0, a very high reading. The GfK consumer confidence survey plummeted for the fourth month to its lowest since November 2020, at -31 from -26 the previous month. Expectations for the general economic situation in the next year dropped by -6 to -49.
Sales: retail sales had a soft month in February, after a strong January and bad December, down 0.30% including automotive fuel and -0.70% excluding automotive fuel. The CBI retailing reported sales fell from 14 to 9 and the total distribution reported sales fell from 26 to 20.
Weaker surveys across the board
Surveys: eurozone consumer confidence fell from -8.8 to -18.7. The eurozone manufacturing PMI went from 58.2 to 57.0 and the services PMI from 55.5 to 54.8. In Germany, the ifo Business Confidence Index fell sharply from 98.5 to 90.8, with expectations dropping the most from 98.4 to 85.1 and current conditions down from 98.6 to 97.0.
Japanese PMIs improving
China: industrial profits rose 5% in the two months of January-February. This compares with 4.2% in December.
Japan: the PMIs were stronger, with the Jibun Bank services PMI rising from 44.2 to 48.7 (but still below 50) and the Jibun Bank manufacturing PMI up a little from 52.7 to 53.2.
Oil prices continued to rise, despite erratic day-to-day movements and Brent ended up almost 12% on the week. Other commodities were less buoyant, with copper slightly down.
Gold finished the week 2% higher, as inflationary talk heated up.