The numbers for the week – 4 Jul 2022
Markets last week
The improvement in risk markets during the previous week could not be sustained due to concerns about a possible US recession and unrepentant statements from central bankers meeting at an offsite in Portugal last week. US Federal Reserve (Fed) Chair Jerome Powell said that the “Fed will not let the economy slip into a high-inflation regime even if this means raising interest rates at levels that put growth at risk”, i.e. acknowledging the recessionary risk caused by the Fed’s policy.
In economic data, US surveys showed a systematic drop in growth momentum, with consumers and manufacturers alike anticipating a slowdown. The widely-followed Atlanta Fed GDPNow forecast was downgraded to -2% growth for the second quarter (Q2), which after the -1.6% in the first quarter (Q1) would technically mean a US recession. However, the recessionary risks that investors are concerned about are more likely to come to the fore late this year or next.
Investors therefore switched their focus from inflation to growth and most markets moved quite sharply to reflect this. Government bond yields slumped in the expectation that the Fed (and other central banks) may not be able to raise rates to the expected levels if a recession truly lies ahead. This was helped by a better inflation reading in the US, at 4.7% vs. 4.9%, on the PCE (personal consumption expenditures), a gauge monitored by the Fed. Oil prices also suffered further drops, although any fall was generally followed by an equally sharp rebound. Against that backdrop, equities could not continue rallying and registered the eleventh falling week in the last 13.
On the positive side, China cut its mandatory quarantine period from three weeks to 10 days for inbound visitors and both Beijing and Shanghai loosened mobility restrictions, helping Chinese surveys rebound and East Asian markets behave better than western equities.
Nevertheless, the market mood turned sour mid-week and the end of Q2 gave rise to a day of reckoning: the worst return for US markets for Q2 and the first half since 1970, more than 50 years ago. An unenviable record. More surprising even was the massive negative return of government bonds, with UK gilts down 14% during the first half of 2022. Within equities, in sterling terms, Europe was the worst market, down 18%, with the US and Japan down 12%. The FTSE All Share was the only single-digit loser among main markets, due to its large energy and commodity component.
During the week, though, bond yields fell sharply, with US 10-year treasury yields down 25 bps to 2.89% (the recent high was 3.47%), UK gilts down 22 bps to 2.08% (high was 2.65%) and European yields down 21 bps. European and US equities fared worst, whilst East Asia and in particular Hong Kong was again the leader. The FTSE 100 was defensive (in contrast with the FTSE 250). Utilities and energy were the only positive sectors during the week, whereas information technology was the biggest loser.
The US dollar once again starred among currencies, but the gold price fell below US$1,800/oz before recovering to US$1,811.
The week ahead
Wednesday: US ISM services index
Our thoughts: one concern among economists is that US inflation is not solely driven by energy and food prices, as is generally the case in other parts of the world, but increasingly by services prices. In that respect, the ISM (Institute for Supply Management) services PMI should give a good reading on orders, backlogs, employment costs, prices, etc. Perversely, any downdraft in the services index would help the inflation battle.
Friday: US employment data for June, plus JOLTS job openings on Wednesday
Our thoughts: everything is tied to inflation right now, but inflation is determined by how successful the Fed can be at slowing down the economy. Employment is crucial to that equation. If the US continues to create 300-400K jobs every month, the Fed’s task will be extremely hard. Any softness in non-farm payrolls would be welcome. In addition, the JOLTS job openings will give an indication of how difficult it will be for monetary policy. At 1.7 job openings per jobseeker, slowing down the employment market is a steep hill to climb. Any reduction in job openings would also help.
Friday: Chinese CPI and PPI
Our thoughts: once again, we are highlighting the difference in the cycle between China and the West. Whereas inflation is still on an uptrend in most western countries, China seems to have broken the back of it, especially through a reduction in the PPI (producer price index). Is this sustainable and what is the current path? The Chinese PPI is also vital for western countries importing large quantities of manufactured products from China. The low CPI (consumer price index) may not necessarily be replicable anywhere else in the world, but if China is truly ahead of the global cycle due to its head-start on the COVID-19 pandemic, then its CPI level would be what we could aspire to in a couple of years.
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Central bankers confirming tighter money policy
The world’s main central bankers met at an offsite in Portugal and provided many comments to the world’s markets.
Fed Chair Jay Powell referred to the end of globalisation, commenting: “Since the pandemic, we’ve been living in a world where the economy has been driven by very different forces.” He highlighted the risk of the world dividing into blocs, with supply chains becoming much less efficient.
European Central Bank (ECB) President Christine Lagarde said: “I don’t think that we’re going to go back to that environment of low inflation.”
Policymakers signalled their clear determination to bring down inflation even at the cost of economic growth. “Is there a risk that we would go too far? Certainly, there’s a risk,” Powell said. “But the worst pain would be from failing to address this high inflation and allowing it to become persistent.”
Investors have been stepping up their anticipation of interest rate hikes, with 75 bps for the Fed’s July meeting now more likely for markets than 50 bps and the increasing expectation that the ECB will raise rates by more than 25 bps also this month.
Surveys unanimously calling for lower growth. A ray of hope on core PCE inflation?
Industry: durable goods orders were up 0.7% for May, whereas non-defence capital goods orders rose at a better-than-expected pace of 0.5% (9.8% year-on-year) to another record high. Wholesale inventories rose 2.0% in May, after 2.3% the previous month, and retail inventories were up 1.1%.
Housing: pending home sales recovered a little, up 0.7% after -4.0% the previous month. The S&P CoreLogic (Case-Shiller) city price index was up 20.39% year-on-year in April and 21.23% for the 20-city index. The FHFA house price index increased 1.6% in April as well. The US mortgage rate rose to nearly 6%, up 2.7% this year. MBA mortgage applications rose 0.7% for the week, after a strong 4.2% the previous week.
Surveys: the Conference Board consumer confidence index fell sharply from 103.2 to 98.7 with all the difference coming from expectations rather than the present situation. Expectations are now the lowest since early 2013. The Richmond Fed manufacturing index slumped from -9 to -19, the lowest in decades other than one month during the COVID-19 pandemic. The Dallas Fed manufacturing activity index dropped from -7.3 to -17.7. The MNI Chicago PMI fell from 60.3 to 56.0.
Finally, the ISM (Institute for Supply Management) manufacturing PMI fell from 56.1 to 53.0, still in growth territory but with low growth ahead likely. The drop was driven by lower orders (at 49.2 vs. 55.1), lower employment (47.3 vs. 49.6) plus a reduced backlog of orders and exports/imports. Manufacturing had been holding up well despite supply chain issues but is now clearly losing momentum.
Inflation: PCE inflation (personal consumption expenditures) improved, with headline PCE at 6.3%, 0.1% better than estimates, and core PCE (the Fed’s gauge) actually down from 4.9% to 4.7%.
Employment: initial jobless claims were steady at 231K vs. 233K last week, with continuing claims down a smidge from 1331K to 1328K.
Consumer: personal income rose 0.5% in May, unchanged, but personal spending fell from 0.9%, revised to 0.6%, to 0.2%.
Surveys falling but credit holding up – housing loans in particular
Prices: the BRC (British Retail Consortium) shop price index rose from 2.8% to 3.1% year-on-year in June.
Surveys: the Institute of Directors’ survey of more than 400 business leaders showed that its measure of economic confidence fell to -60 in June, down from -45 in April and the lowest since the COVID-19 outbreak in early 2020. The Lloyds business barometer slumped from 38 to 28 in June.
Housing: the Nationwide house price index had softer growth in June, up 0.3%, vs. 0.9% the prior month, for a 10.7% year-on-year increase.
Credit: net consumer credit fell in May from £1.4bn to £0.8bn. Net lending secured on dwellings, on the other hand, surged from £4.2bn to £7.4bn, with mortgage approvals almost unchanged at 66.2K.
Money supply: money supply was strong, up 0.5% in May for a 5.1% year-on-year increase, up from 4.9%.
No end to the inflation surge
Inflation: the eurozone CPI rose to 8.6% in June, up from 8.1% in May. Food and energy prices continue to be the main drivers and core CPI inflation fell 0.1% to 3.7%. The French PPI was still sky-high at 27.3% year-on-year in May, only marginally down from 27.9% the prior month.
Money supply: eurozone money supply eased from 6.1% to 5.6% year-on-year in May.
Surveys: confidence was fairly stable in the eurozone in June, with economic confidence down to 104 from 105, industrial confidence up from 6.5 to 7.4, services confidence rising from 14.1 to 14.8 and consumer confidence unchanged at a low -23.6.
Employment: the German unemployment claims rate unexpectedly surged from 5.0% to 5.3% in June, apparently on the influx of Ukrainian refugees.
Consumer: German retail sales in May rose 0.6%, recovering somewhat from a more than 5% drop the previous month. French consumer spending rose 0.7% in May after a negative -0.7% month.
Chinese surveys bucking the global trend and rising
China: the official (CFLP) PMIs were strong. The manufacturing PMI disappointed a little, just above 50, but the non-manufacturing PMI soared from 47.8 to 54.7, probably as a result of COVID-19 restrictions being loosened. The unofficial Caixin manufacturing PMI rose sharply from 48.1 to 51.7.
Japan: the Tankan survey for Q2 was mixed, with large manufacturing soft, large non-manufacturing better, small manufacturing unchanged and small non-manufacturing improving. The consumer confidence index dropped from 34.1 to 32.1.
Vehicle sales were down 15.8% year-on-year in June, better than the previous -16.7%. Retail sales overall rose 0.6% in May, for a year-on-year growth of 3.6%, up from 3.1% previously. May housing starts dropped 4.3%, down from +2.4% the prior month.
The jobless rate edged up from 2.5% to 2.6% in May.
Copper shows recession concerns
Oil volatility remained very high, with Brent see-sawing between extremes of US$107/bbl and US$116. Crude prices were hit by recession fears but recovered on further supply tightness due to the Ukraine war. Copper prices were more representative of the market’s recessionary worries, falling 4% and down 25% from their peak in March.
Growth concerns driving bond yields down indirectly hit gold prices, which fell below US$1,800/oz, before recovering to US$1,811.