Markets last week
Volatility was the order of the day last week, with the US Federal Reserve (Fed) driving markets down on Wednesday afternoon and the US employment report boosting the mood on Friday.
In a tale of two central banks, the Fed and the Bank of England (BoE) both raised rates by 75 bps yet delivered opposing messages which caused different market reactions. The speech by the Fed’s Chair, Jay Powell, was followed by eager markets, which moved with each sentence. The Fed communicated a hawkish view that the pace of rate hikes may begin to slow but the terminal rate is expected to be higher than priced in by markets. US equities had their worst return for any Fed decision day since January 2021.
On the other hand, BoE Governor Andrew Bailey conveyed more limited upsides to rate hikes together with fears of a protracted UK recession. As the Sunak and Hunt pivot on taxes had been well received, with gilts and sterling stable throughout the week, it made the BoE’s message less damaging to British markets.
On balance, the global inflation picture was worse, despite mixed data: in the US, the sharp rise in job openings, jobless claims near historic lows, the higher manufacturing employment index, the smaller job cuts and non-farm payrolls above estimates, all more than offset the lower unit labour costs in Q3. In the UK, the British Retail Consortium (BRC) shop price index surged although the house price index fell. The lower import price index in Germany hardly registered, as it was still close to 30% year-on-year and eurozone producer prices were still above 40%. Against that backdrop, it is hardly surprising that central banks kept delivering a hawkish message and large interest rate hikes.
President Biden made comments about a potential windfall profit tax on energy, but markets ignored it as it has virtually no chance of passing through Congress either before the mid-terms (during the session between the elections tomorrow and year-end) or afterwards (after the new Congress is inaugurated next year).
Bond yields continued their upward rise as the two-year US treasury yield hit the highest level in 15 years on Friday. US and eurozone bond yields surged, but gilts were more subdued, in line with the more market-friendly new government.
Crude oil recovered significantly, up 5% on Brent, whilst industrials metals soared with copper up 7%. Supply constraints were the main reason. Also, gold rose by 2% against the backdrop of a stable US dollar. Sterling did, however, drop 2% versus both the US dollar and the euro after its initial ‘Sunak bounce’.
Equities were positive but mixed during the week. There was a massive Chinese market rebound due to totally unconfirmed rumours that a ‘reopening committee’ had been formed to assess various reopening scenarios from COVID-19 zero. Despite denials by Chinese officials, Hong Kong and mainland markets were very well supported throughout. Over the week, US equities lagged everything else, as technology was by far the worst sector, whilst energy surged. Asia and emerging markets were the stars, but European and UK equities also performed strongly.
The week ahead
Tuesday: China Consumer Price Index (CPI) and Producer Price Index (PPI)
Our thoughts: China is deriving some indirect advantages from its zero COVID-19 policy lockdowns. The weaker economy is causing inflation to come down quite sharply, with the CPI quite close to where western central banks would like their inflation to be, and the PPI collapsing to the point where it is expected to turn negative. This has an impact on the rest of the world which imports manufactured products from China. Falling producer prices and a weaker Chinese currency are helping goods prices all over the world.
Our thoughts: Will inflation moderate in the US? The CPI is the most visible price gauge. What will matter to the Fed is not just the direction of the number, but the speed of movement and the difference between the headline and core readings. In an environment where energy prices are falling and goods prices have clearly peaked, services inflation has taken over and hence the core CPI ex food and energy will be the number to watch.
Friday: UK September growth breakdown
Our thoughts: Will any part of the British economy do well in September? Growth has been falling recently. Manufacturing has been challenged, but services which are the greatest share of the UK economy, have not offset the drop. Will construction help or is it now following the housing market downwards? Expectations are quite subdued for the UK in September but could nevertheless be challenged.
The numbers for the week
Central banks/fiscal policy
Fed and BoE both deliver 75 bp hikes but Fed’s message spooks markets
The US Federal Reserve (Fed) raised rates by 75 bps (to 3.75%-4.00% – lower and upper bound -), as widely expected, but the language was modified meaningfully and moved markets. The sentence that was noted the most was: “in determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments”.
There were other comments, though, to the effect that the ultimate level of rates could be higher than previously expected and that the Fed was concerned about the risk of easing too soon, with reference to the ‘stop and go’ policies of the 1970s. The bottom line was that a pause in hiking rates is possible, but not yet. This led to a sharp drop in US equities and bond prices, leading to a surge in US treasury yields after the comments were made.
The Monetary Policy Committee (MPC) of the Bank of England (BoE) delivered its biggest interest rate increase in 33 years, voting by 7-2 to hike rates by 75 bps to 3%, the highest level in 14 years. The MPC pushed back against market expectations for the scale of future increases, for fear of a two-year recession and emphasised that the peak in interest rates would be “lower than priced into financial markets”.
BoE Governor Andrew Bailey also referred to the UK’s political turmoil, saying that “there has been a UK premium on rates. If you look at how UK rates have moved since we were here at the beginning of August compared to the euro area and the US, they’ve all gone up, but the UK clearly went up far more, and it went up during this period when there was considerable turmoil in the markets”.
Not to be outdone by the Fed and BoE, European Central Bank (ECB) President Christine Lagarde said that a eurozone recession alone would not be sufficient to bring inflation back down to the 2% target and hence a restrictive level of interest rates had to be reached. “Our job is far from completed and withdrawing accommodation may not be enough to bring inflation back to our target.”
The US mid-term elections tomorrow have the potential to move certain markets and investments, but it is also possible that we may not know the result of certain key races for several days. The House of Representatives seems to be almost universally predicted to flip from Democratic to Republican majority, but the Senate may be more contested.
Very strong employment market doesn’t bode well for ongoing inflation despite weaker surveys and lower unit labour costs during Q3
Surveys: the MNI (Market News International) Chicago PMI (also known as Chicago business barometer) fell from 45.7 to 45.2 and the Dallas Fed manufacturing activity index dropped from -17.2 to -19.4, both worse than expected. The bellwether ISM (Institute for Supply Management) manufacturing PMI fell from 50.9 to 50.2. the details were mixed, with new orders at 49.2 up from 47.1, production at 52.3, backlogs below 50 and employment at 50.0, up from 48.7, but supplier deliveries at 46.8 and inventories falling to 52.5. Prices fell sharply from 51.7 to 46.6. The ISM services index fell from 56.7 to 54.4, below estimates.
Employment: the JOLTS (Job Openings and Labour Turnover Survey) defied estimates of a ½ million drop to rise from 10053K to 10717K in September. The job cuts calculated by Challenger, Gray & Christmas fell to 48.3% in October from 67.6% (i.e. there were fewer job cuts). Jobless claims remained moderate, with initial claims down from 218K to 217K but continuing claims rising from 1438K to 1485K. The monthly non-farm payrolls number fell from 315K to 261K in October but was higher than estimates and the previous month was revised upward. Due to the labour force participation rate falling from 62.3% to 62.2%, the unemployment rate (U-3) edged up from 3.5% to 3.7% and the underemployment rate (U-6) from 6.7% to 6.8%. In addition, the average hourly earnings rose from 0.3% to 0.4% for the month for a 4.7% year-on-year growth.
Housing: construction spending was up 0.2% in September, from a negative -0.6% the prior month. MBA mortgage applications fell 0.5% after -1.7% the previous week.
Industry: total vehicle sales, as reported by Wards, jumped from 13.49m annualised rate to 14.9m in October. Factory orders rose 0.3% in September, from 0.2% the prior month, but ex transportation fell 0.1%.
Trade: the US trade balance worsened from a US$65.7bn deficit to US$73.3bn.
Inflationary factors: non-farm productivity improved to +0.3% in Q3 from -4.1% the previous quarter whilst unit labour costs fell sharply from 8.9% to 3.5%.
Data are not (yet) supporting Governor Bailey’s assertion of a two-year UK recession
Credit: consumer credit grew by 7.2% year-on-year in September, up from 7.1% previously, whereas net lending securitised on dwellings fell from £6.1bn to £5.2bn, as mortgage approvals dropped from 74.4K to 66.8K.
Money supply: money supply recovered with M4 rising 5.4% year-on-year in September, up from 3.9%, but the 3-month annualised number swelling from 2.3% to 14.7%.
Housing: house prices are starting to show some significant downside. The Nationwide House Price Index fell 0.9% in October, for a year-on-year growth of 7.2%, down from 9.5% the prior month. The S&P Global/CIPS construction PMI rose from 52.3 to 53.2 against estimates of a drop.
Industry: new car registrations in October soared to 26.4% year-on-year from 4.6%.
Inflation: inflation is still rising, with the BRC (British Retail Consortium) Shop Price Index up from 5.7% to 6.6% in October.
Inflation still out of control
Inflation: the eurozone Consumer Price Index (CPI) rose from 10.0% to 10.7% in October with the core CPI (ex energy, food, tobacco and alcohol) also up from 4.8% to 5.0%. The import price index in Germany fell from 32.7% to 29.8% in September. The eurozone Producer Price Index (PPI) fell slightly from a record 43.4% to 41.9%.
Employment: the eurozone unemployment rate eased from 6.7% to 6.6% in September.
China: the unofficial Caixin manufacturing PMI increased from 48.1 to 49.2, whereas the Caixin services PMI fell from 49.3 to 48.4. Trade figures were subdued, with exports falling 0.3% year-on-year vs. +5.7% the prior month and imports falling 0.7% vs. +0.3%.
Japan: vehicle sales were well supported, rising from 17.8% year-on-year to 19.7% in October. The monetary base continued to shrink, falling 6.9% year-on-year in October, from -33.3% the previous month.
Crude oil recovered significantly, up more than 5% on Brent, whilst industrials metals soared with copper up over 7%. Supply constraints were the main reason. Also, gold rose by 2% against the backdrop of a stable US dollar.