Month: December 2022

Central Bank rhetoric leads markets lower

In a week that was dominated by major central banks action, equity markets finished broadly lower. Markets came under pressure by the end of the period after central banks, particularly in the US, Eurozone and UK all raised interest rates and signalled the fight against inflation was not over.

In the US, the Federal Reserve (Fed) took the unanimous decision to raise its target interest range by 0.5% to a range of 4.25% to 4.5%. Whilst this was anticipated by investors and ended the successive 0.75% rate rises of late, it was the hawkish tones of meetings that sent stocks lower. Fed Chair, Jay Powell, said it would take “substantially more evidence to give confidence that inflation is on a sustained downward path”. Meanwhile, in Europe, the European Central Bank (ECB) also raised rates by 0.5%, with comments from the ECB that “inflation remains far too high”. In the UK it was a similar story with the Bank of England also raising rates by 0.5%, to 3.5%, the highest level in 14 years. Again, the central bank warned of likely further tightening.

As of 8.30am London time, given the outlook of tighter monetary policy, the US ended lower by 0.98%, with the US technology index down further by 1.78%. UK and European stocks also struggled, lower by 0.67% and 2.19% respectively. Weaker Chinese retail sales and uncertainty over rising Covid numbers did not help matters, with the Hong Kong index falling 2.17% and the Shanghai Composite also down for the week by 1.22%. The Japanese market fell by 0.58%, and the Australian market declined by 0.89%.

Global growth worries keep investors nervous

In addition to the prospect of further monetary tightening, economic data releases this week did no favours for investor sentiment. China, despite a gradual ease of restrictions, still posted disappointing retail sales and industrial production, both declining 5.9% and 2.2% respectively year on year, worse than forecast. Meanwhile, Japan’s manufacturing activity shrank at the fastest pace in more than two years in December. US retail sales also disappointed falling 0.6% month on month, the biggest drop in 11 months. That said, in the US, 211,000 Americans applied for unemployment aid in the past week. This was less than last week and lower than forecast, signalling that the domestic labour market is still tight and likely to rationalise the Feds decision to keep rates higher.

Yield curve inversion remains entrenched

Shorter-term bonds in major economies continue to trade at higher yields than longer-dated bonds, and this inverted relationship to the normal is one that signals an impending recession. Bond yields, which move inversely to their price, fell marginally despite the rate move this week; the 2-year US treasuries fell by 10 basis points to 4.24% as of 8.30am London time and with the US 10-year treasuries trading at 3.47%, this illustrates the inversion in the yield curve.

In Europe, shorter-term debt reacted more to central bank action with 2-year German bund yields rising by 30 basis points to 2.45% whilst its longer 10-year debt trades at 2.16%. In the UK bond moves were less muted with 2-year Gilts rising just 3 basis points over the week to 3.45% whilst 10-year gilts trade at 3.3%.

Optimism over China’s Covid restrictions helps oil price rises

The demand outlook for China, the biggest oil importer in the world, continues to improve with its re-opening after harsh Covid lockdowns. Brent crude traded back above $80 per barrel marking a 6.08% rise, whilst WTI crude oil trades at $75.54 per barrel, a 6.36% increase. The shutting of the Keystone pipeline across Canada and US due to a leak also limited short-term supply earlier this week.

Strength in the US Service Sector raises concerns over further rate rises

Data released this week surprised economists by pointing to continued strength in the US service sector, despite the sharp increase in interest rates. The Institute for Supply Management Service Sector index was released on Monday, which provides an insight into the business conditions faced by service sector companies. The index came in at 56.5 for the month of November, up from 54.4 in the previous month (any number above 50 equals expansion, and below 50 contraction), and higher than the decline forecast. This unsettled markets trying to gauge when the Federal Reserve may pause their interest rate hiking cycle, designed to crush the sharp increase in inflation, but risking triggering a recession as a result.

Chinese equities continue to rally, despite weak import and export data

However, despite some very weak import and export data for the past twelve months, both domestic ‘A’ shares and offshore Hong Kong stocks in China made further gains this week, on a gradual relaxation of zero Covid rules. China has increasingly been seen to target economic growth over the virus for the first time since the pandemic began, accelerated by the wave of protests witnessed across China at lockdown rules.

As of 12pm on Friday, London time, US equities fell 2.7% over the week, with technology stocks dropping 3.3%. European markets fell 1.4% and UK equities slumped by 1.4%, with more domestic orientated mid cap stocks falling by 3.1%. Australian stocks fell by 1.2%, whilst Japanese equities bucked the trend in developed markets, rising 0.4%. Although for overseas investors this was all but lost through Yen weakness, which fell by 0.9% versus Sterling and 1.3% versus the Dollar. Emerging markets lost 0.5% despite Chinese and Hong Kong stocks rising by 1.6% and 6.6% respectively. The weakness came predominantly from Latin America, where markets fell by 3.0%, not helped by a sharp fall in the price of crude oil.

Government bond yields were broadly stable over the week, with the yield on 10-year US Treasuries now trading at 3.49%, German Bunds 1.88% and UK Gilts 3.12%.

Crude oil prices fall sharply, despite the European ban on Russian seaborne oil deliveries

Crude oil prices fell sharply in a week that Europe banned all seaborne Russian oil imports and the G7 countries imposed a $60 price cap. Although many thought this would have sent oil prices higher, a number of factors conspired to send crude oil around 10% lower. OPEC, the Organisation of Petroleum Exporting Countries, chose not to alter their production targets, having been expected to make cuts in response to the price cap. Future demand fears trumped supply constraints. This was exacerbated by the strong service sector data out of the US, raising concerns of the Federal Reserve sending the US into recession through further rate rises. And finally, the more limited supply destinations available to the Russians has meant Asian refiners have been able to negotiate lower prices. Brent crude is now trading at $76.3 a barrel and US WTI (West Texas Intermediate) $72.

Industrial metals rise as China relaxes Covid restrictions

Industrial metals made gains, helped by the gradual relaxation of covid restrictions in China. Copper rose by just over 1%, trading at $8,525 a tonne, and iron ore rose by almost 5%. Gold prices are up slightly, now priced at $1,813 an ounce.

Issues under discussion

China’s switch to prioritising growth over health

Chinese ‘A’ shares have risen by over 10% since hopes have grown as to an end to the zero Covid policy, and offshore Hong Kong stocks have gone up by a massive 35% from very cheap, oversold levels. Whilst this continues to look like a gift to investors, especially against a difficult backdrop of western countries tightening monetary policy to combat inflation, there remain a number of headwinds for China’s switch to prioritising growth over health.

The efficacy of the Chinese vaccine is lower than those used in the developed world; the capacity of hospitals to deal with any sharp increase in Covid infections that comes with opening up is limited; and there remains a sizeable proportion of the population who are unvaccinated. All of this together means that although the opportunity in China looks attractive, as always, there remain plenty of risks.

US stocks rallied for the second consecutive month since 2021

Most equity markets managed to finish the week in positive territory as of 8am London time, with the US stock market recording the first back-to-back monthly gains since mid-2021, with a sharp rally on the last day of November. The start of the week was marked by volatility especially in Chinese and Asian markets, as protests broke out in cities across China against the government’s continued strict Coronavirus lockdowns. However, equities rebounded strongly on Wednesday, led by the US, after Federal Reserve (Fed) Chair Jay Powell suggested it may be appropriate to slow the pace of interest rates rises.

After a series of 0.75% interest rate increases, Powell suggested the central bank could raise rates by 0.50% instead and that there could be a path to a soft landing, if labour markets cool without the economy entering a recession.

As of Friday, 8am London time, the US finished up by 1.28% with the US technology sector strengthening even higher by 2.28%. Returns in the UK and Europe were more modest, with both markets rising 0.96% and 0.73% respectively. Asian equities also rebounded by the end of the week on signals that the Chinese government was willing to ease lockdowns to appease the public. The Shanghai index finished the week up 1.76%, whilst the Hong Kong index rallied remarkably by 6.44%. Japan was an outlier, falling by 3.17%, as the export heavy index was weighed down by a stronger Yen.

The US dollar weakens against major currencies

Following Jay Powell’s remarks and a shift in market expectations over Fed rate rises, the US dollar weakened against its peers. The DXY, the measure of the dollar against a basket of major currencies fell 1.2%. Since September the dollar has weakened 8%. Inflation data out of the US on Thursday also contributed to the currency weakness with the Fed’s preferred measure of inflation, the US Core personal consumption expenditures index, rising by 0.2% in October, lower than the expected 0.3% rise. As of Friday, investors have turned their focus on the US jobs numbers which will be released today. Economists are expecting US non-farm payrolls to increase by 200,000, a decline from October’s reading of 261,000.

Government bonds extend gains

Major government bonds also strengthened on the back of Powell’s dovish comments. The benchmark 10-year US treasury yield (which moves inversely to the bond’s price) declined by 15 basis points to trade at 3.5%. Whilst the yield on the more interest rate sensitive 2-year US Treasury, declined by 19 basis points to 4.25%. Meanwhile, benchmark 10-year German bund yields and UK Gilts finished the week trading at 1.8% and 3.1% respectively.

Crude Oil prices strengthen after a string of weekly declines.

With news that some Chinese cities are relaxing their Covid measures, hope of higher oil demand pushed Brent crude oil prices higher by 3.81% to $86.82 per barrel as of Friday 8am London time. The WTI crude price rose by 6.67% over the week. Oil prices were also supported by reports that the US administration may pause sales from its strategic petroleum reserve.