Month: August 2022

Markets continue to look for signs of an interest rate pivot in the US

Bond yields, which move inversely to price, moved higher, as investors await the hotly anticipated speech from Jerome Powell, chair of the US Federal Reserve (Fed) on Friday, as interest rate policy continues to dominate markets. Expectations are high that without giving away any details on further rate rises, the Fed chair will be keen to burnish his credentials as being tough on inflation. With economic data beginning to point towards a slowdown, investors are looking for any sign of a pivot away from the current trajectory of rate increases, which has been running at an increase of 0.75% for the last two rate setting meetings. Currently markets are pricing in a peak in US rates of around 3.8% in March 2023, with peak rate expectations gradually increasing in recent weeks, with the peak priced in as low as 3.2% at the end of July.

As of 12pm on Friday, London time, US equities are down 0.7% over the week, whilst the US technology sector has fallen 0.5%. European stocks have lost 1.3%, and the UK market is down by a similar amount, having dropped 1.2%, not helped by the continued escalation in natural gas prices. The Japanese market is down 0.75%, whilst Australian equities fell 0.2%. Emerging markets bucked the trend, rising 0.2%, with Latin American stocks increasing by 3.1%, helped by the recovery in commodity prices in recent weeks.

Interest rate expectations gradually ratchet higher

Government bond yields rose, with shorter dated bonds rising the most. The yield on 2-year US Treasuries touched 3.40% mid-week, before settling back down at 3.37%. The 10-year Treasury is currently trading at a lower yield of 3.07%, meaning that the 2-year 10-year yield curve remains inverted, which many investors (but notably not the Fed) believe is a signal of an upcoming recession. The UK yield curve is also inverted, with 2-year gilts trading at a yield of 2.80% versus 2.61% for 10-year gilts. Whilst perhaps counter intuitively the German bund yield has yet to invert, with 10-year bunds trading at a yield of 1.35%. Futures markets are currently pricing UK rates rising to 2.8% by the November meeting, versus 1.75%, with rates rising to 4.0% by March. Whilst Eurozone rates are priced to rise from zero today, to 1.3% by December.

UK retail energy price cap rises by 80%, with further rises forecast

Gold fell 0.3% over the week, now priced at $1,758 an ounce, whilst industrial commodities continued their recent renaissance. Brent crude rose 4.4%, trading at $101 a barrel, copper was up 0.8%, at $8,167 a tonne, and European natural gas increased a whopping 28% over the week, priced at $318 a megawatt hour. On Friday the UK regulator increased the price cap on household gas and electricity bills from £1,971 a year to £3,549, an 80% increase. However, this is due to be reviewed again in January, with the latest industry forecasts suggesting the cap could rise to over £6,600 a year by the spring. If this comes to pass, this would be more than a fivefold increase on the price cap set in October 2021.

Bad news is good news as US economic data shows continued signs of softening

US home sales data softened further this week, as the annualised figure for July of newly built homes fell by 12.6%, versus forecasts of a 2.5% fall. Meanwhile the latest service sector purchasing managers’ index, which measures the business conditions service sector companies find themselves in, came in at a 27-month low of 44.1, with any reading below 50 representing contraction, also worse than forecasted. With a focus on interest rates, bad news is good news, as this drip, drip, drip of softening economic data may help the Fed to pivot on its rate hiking path. However, Neel Kashkari, president of the Minneapolis Fed, who has previously been perceived as more dovish on US central bank policy (less inclined to raise rates), was quoted this week saying that a combination of “maximum employment” and “very high inflation” makes the Fed’s approach “very clear, we need to tighten monetary policy to bring things into balance.”

Mixed economic data and company results have led to a similarly mixed week in markets

It has been a mixed week for markets as economic data and company results were mixed, providing little direction. Whilst there are some signs of cooling growth, such as in the US housing market, other areas, such as employment, remain robust, pointing towards further rate rises. And, whilst China has been gently easing monetary policy this year, the country’s zero covid policy continues to sap consumer confidence, which has been reflected in lacklustre retail sales growth and rising unemployment.

Dollar strength returns

As of 12pm on Friday, London time, US equities were up 0.1% over the week, although investors based outside of the US were able to benefit from renewed dollar strength. The Dollar index, which measures the value of the dollar against a basket of internationally traded currencies, strengthened by a massive 2.2% over the week. US technology stocks, faced with rising expectations of further rate tightening, fell 0.6%. European markets dropped 0.45%, not helped by European natural gas futures rising by almost 20% over the week alone, having risen 250% year to date. UK stocks rose 0.2%, although weakness in sterling accounted for much of this. More domestically orientated UK mid cap stocks fell 1.9%. Japanese equities rose 1.1%, aided by currency weakness, with the Yen falling against most major currencies, as unlike other major central banks monetary policy remains very accommodative under the Bank of Japan as inflationary pressures remain muted. Australian shares rose 1.2%, supported by very strong results from commodity producers. Emerging markets fell 0.7%, with the Hong Kong Hang Seng falling 2.0%.

UK inflation data leads to a selloff in short-dated government bonds

Developed market government bond yields rose (yields move inversely to price) this week as economic data on balance pointed to continued rate hikes. The 10-year yield on US Treasuries is now trading at 2.9%, German bunds 1.22% and UK gilts 2.44%. The bigger move was in shorter dated bonds following the latest release of inflation data out of the UK. Consumer price inflation came in at 10.1% for the year to July, higher than last month’s reading of 9.4% and above forecasts of 9.8%. Short-dated gilts rose over half a percent as the market reappraised UK interest rate expectations, with the 2-year gilt now trading at 2.59%, dragging the yield up on both US Treasuries and German bunds mid-week.

Crude oil slips further

Crude oil fell, with Brent crude down by 3.6%, now trading at $94.6 a barrel. Copper prices were also weak, falling 0.5% to $8,045 a tonne. Iron ore shed 8.6% on the back of weak Chinese economic data. Meanwhile gold suffered from the rally in the US dollar, falling 2.8% to $1,764 an ounce.

Zero covid policy continues to take its toll on China’s economy

The week began with disappointing data out of China, with both retail sales and industrial production coming in lower than forecasts. China continues to lock down cities as a key part of its zero covid policy resulting in lacklustre economic growth. Youth unemployment has risen to a record high of 19.9%. The People’s Bank of China reduced its medium-term lending rate by 0.10%, but expectations are growing for further easing.

US housing market continues to soften, whilst employment picture remains robust

In the US, new home construction moderated to its lowest level since mid-2021, with housing starts falling by 9.6% from the previous month. However, the DIY store Home Depot reported its highest quarterly sales and earnings on record as consumers continue to spend on home improvement despite the high levels of inflation. Following two sets of profits warnings, the hypermarket chain Walmart reported stronger than expected figures and raised their full year guidance, whilst the department store Target Corporation missed earnings forecasts and described the operating environment as “very challenging”. The employment picture continues to remain more robust than expectations as initial unemployment claims came in beneath expectations.

Softening inflation powers markets upwards

In a choppy market, equities made further gains following the latest US inflation data, providing the possibility that peak inflation is behind us. Consumer price inflation (CPI) came in at 8.5% for the year to July, down from 9.1% the previous month, and for the month of July itself inflation was flat. Falling petrol prices were the main contributing factor.

As of 12pm on Friday, London time, US equities rose 1.5% over the week, with the technology sector gaining 1.0%, having risen just over 20% from its recent trough. European equities, despite the soaring cost of natural gas, also made gains rising 1.1%, whilst UK equities were up 0.7%. The Japanese market increased by 1.3%, but the Australian market could only manage a gain of 0.2%. Emerging markets rose 1.1%, helped by dollar weakness and an increase in commodity prices, with Latin America rising by 4.9%.

Developed government bond markets were relatively benign, with 10-year US Treasury yields rising (yields move inversely to prices) to 2.87%, German bunds 0.99% and UK gilts 2.10%.

Gold prices moved up 0.5%, now trading at $1,800 an ounce, whilst industrial commodities and crude oil showed greater strength. Copper increased by 3.9%, to $8,165 a tonne, and Brent crude rose by 3.6%, priced at $98.3 a barrel. Whilst futures in European natural gas, for delivery in one month, rose almost 10% over the week, having risen over five-fold year to date and over sixteen times since the start of 2020, pre the pandemic.

Tech stocks start the week on weak note following disappointing corporate results

Markets started the week on a sour note, as results from US chipmaker Micron Technology warned of slowing consumer demand for chips in personal computers and smartphones. This followed weak guidance from Nvidia, also a manufacturer of semiconductor chips, as revenues for the second quarter fell 19% versus the first quarter, with revenue from gaming components being behind the fall. However, market sentiment improved swiftly on the release of the CPI data, although inflation remains at very elevated levels. On Thursday, the latest index for prices paid (PPI) to US producers for goods and services also came in unexpectedly low, with PPI dropping by 0.5% in the month of July, the first decline since April 2020.

Interest rates set to continue climbing despite the softening inflation data

Whilst it remains too early to call the top in inflation with any great certainty, the softening in prices in recent months has been taken very positively by markets, with world equity markets having risen by over 12% since their recent lows. However, the softening in inflation data does not signal the end of interest rate rises and by extension, nor does it remove the threat of a recession. And, as on cue, data released out of the UK on Friday showed a contraction in the economy of 0.1%, versus growth of 0.7% in the previous quarter.

Attention turns to US economic data

After a strong July for global markets, the first week of August saw more moderate returns amongst equities as investors keenly anticipate today’s US labour market data. With the US already in a technical recession (two consecutive quarters of negative growth), extra focus is being paid to other economic indicators for the largest economy in the world. Economists have forecast US non-farm payrolls to have added 275,000 jobs, down from 372,000 last month. Meanwhile, on Monday, the US Manufacturing Purchasing Managers’ index (PMI), a survey of economic activity, slipped to 52.8. Although the reading is above 50 indicating economic expansion, the PMI figure is the lowest since June 2020.

Geopolitical fears resurface

US House of Representatives Speaker, Nancy Pelosi, began her tour of Asia with a controversial visit to Taiwan. Taiwan is self-ruled, but the Chinese government strongly views the country as a breakaway province which should ultimately belong to China. Upon landing, Pelosi reiterated US support for Taiwan, but this prompted a furious response from Beijing. The Chinese government called the visit a “provocative move” and has since held military exercises around the island in a furious response. The inflamed tensions and fear of escalation within the region briefly prompted a demand for haven government bonds and stock markets faltered on the day.

Despite this, most equity markets did however finish the week in positive territory. As of 12pm London time, the broader US index rose by 0.52% whilst the main US technology index had a strong week, up 2.66%. This was helped by better than expected earnings results from PayPal and Moderna. Returns were more muted in the UK, up by just 0.18% whilst continental European equities traded marginally lower by 0.07%. In Asia, as alluded to, the tensions around Taiwan weighed on equity returns within the region. The Japanese market finished higher by only 0.35%, whilst the Hong Kong Index returned just 0.19% for the week. The Shanghai composite traded negatively ending the week by -0.80%.

Hawkish comments hold back government bond returns

After last week’s suggestion from the US Federal Reserve (Fed) Chair that the pace of interest rate increases could be slowed down, this week saw much more hawkish comments from Fed officials. For example, San Francisco Fed president Mary Daly remarked the bank was “nowhere near” done with its fight against inflation, whilst other members of the Fed in separate interviews were open to larger interest rate rises.

Shorter dated government bonds, which are more sensitive to interest rate expectations, sold off on the remarks with the 2 year US treasury yield (which moves inversely to its bond price) rising 22 basis points to breach 3%. Longer dated US government bond yields also rose, with the 10-year benchmark yield finishing the week trading at 2.69%. 10-year German bunds traded flat, with its yield only higher by 3 basis points at 0.84%.

Bank of England makes largest rate increase in 27 years.

Although UK gilt yields ended higher for the week, there was brief demand for UK haven bonds when the Bank of England forecasted the UK economy would fall into recession by this year. The 10 year gilt yield trades at 1.92% as of 12pm London time. Following the 0.75% hike by the US Fed and a bigger-than-expected 50% increase by the European Central Bank, this week saw the Bank of England also raise rates by 0.5% to 1.75%. The central bank cited the large move given fears that inflation will become “embedded” in the economy. They forecast inflation could peak at more than 13% and stay at “very elevated levels” throughout much of next year, before eventually returning to the Bank’s 2% target in 2024.

Oil prices slip to their lowest levels since February

With so much attention and continued concern over the health of the global economy, oil prices fell significantly from their peaks. Brent crude oil fell sharply by -14% to trade below the $100 mark at $93.69 per barrel. WTI crude prices also fell significantly, trading lower by -10% to $88.34 per barrel.

Equity markets set for their best month since late 2020

Markets are set for a strong finish to the week, as investors were encouraged by comments made by US Federal Reserve (Fed) Chair, Jay Powell. The central bank raised its federal fund’s rate by 0.75% to a range of 2.25% to 2.50%, which was widely expected. However, comments from Powell that the central bank may soon slow the pace of further rate rises were well received by investors. Although inflation remains high, central bankers are looking to raise rates without choking off growth and consequently, stock markets have tended to react positively to any indication of less hawkish monetary policy.

As of 9am London time, the US index and the US technology sector both finished higher by 2.8%. Markets in Europe followed suit, with the European index up 2.36%, whilst the UK market rose by 1.2%. Asian stocks gave a mixed picture, however. Australian equities posted a strong gain of 2.26%, but the Hong Kong index dropped by 2.55%, following heavy selling in Alibaba after several executives stepped down. The Shanghai composite finished lower by 0.89% with investors disappointed by the lack of any new stimulus announcements from the Chinese government politburo meeting on Thursday.

Well received company earnings boost equity performance.

What also helped performance this week were well received earnings updates from several bellwether companies. US Technology giants Microsoft and Google parent Alphabet signalled better than expected full year forecasts, even if quarterly revenues were behind initial expectations. Microsoft and Google stock prices rose 6.6 and 7.7% on the announcements. Meanwhile Amazon shares leapt 14%, after revenue results beat expectations. The company also offered an upbeat outlook for the rest of the year on the strength of its cloud computing business. It was not all good news however, major retailer Walmart dropped 7.6% after the company issued its second profit warning since May, citing rising prices for fuel and goods weighing on demand.

Away from the US we also saw a strong earnings boost in the UK for energy giants Shell and British Gas owner, Centrica. Shell attributed its record profits of £9.4bn in the second quarter due to higher energy prices and gas trading, whilst Centrica enjoyed £1.3bn operating profits boosted again by rising energy prices as well as asset sales.

US economy in “technical” recession

A day after the Fed meeting, data revealed US Q2 GDP growth falling 0.9% on an annualised basis. This followed a contraction of 1.6% in the first quarter of this year, putting the country into a technical recession, as defined as two consecutive quarters of negative growth.

However, it is the National Bureau of Economic Research (NBER) who officially declare whether the economy is in recession, based on a range of factors such as GDP, real income, and employment. They have yet to designate the US as being in a recession, whilst the White House has also pushed back on the idea of being in a recession, citing robust monthly job creation.

Nonetheless, US government bonds rallied on the news. Safe haven 10-year government bonds returned 1% for the week, with its yield falling by 6 basis points to trade at 2.69% as of 9am London time. Equivalent UK Gilt yields and German Bund yields also declined, by 10 and 16 basis points respectively to trade at 1.9% and 0.88%.

European gas prices jump higher

In other news, European gas prices rose as much as 13% on Wednesday as flows from the Nord Stream 1 pipeline from Russia to Germany were cut to just 20% normal capacity. European politicians have accused Russia of weaponizing gas supplies in response to sanctions imposed following the invasion of Ukraine. Gas supplies were already cut to 40 per cent of capacity in June before Moscow threatened to make further cuts this week.