Australia
Summary
- Economic activity shows signs of improvement in the US and Europe, but UK below expectations.
- Canada’s central bank hikes but signals the end is in sight; ECB remains hawkish.
- Better than expected data support for equity markets pushes US and European bond yields higher.
- Positioning: an improvement in the economic outlook may lead to a regime change; less negative for risk assets.
- Next week: Monetary policy decisions and company earnings likely to guide market action.
Weekly review
Economic activity showing signs of improvement in the US and Europe, but UK below expectations
US Q4 GDP rose by 2.9% (on an annualised basis), down from 3.2% in Q3 but ahead of forecasts. Inventory builds continued, while consumer spending was lower than forecast. This tone was echoed in Europe, as the Eurozone Consumer Confidence Index marked its best level for almost a year. The eurozone composite purchasing managers’ index (PMI) for January also rose above the 50.0 level (which separates contraction from expansion) to 50.2, ahead of market forecasts and up from December’s 49.3. It was the first reading above 50 for seven months, as the services sector improved, and manufacturing fell by less than expected. Meanwhile, the German government revised its 2023 economic forecast higher, from a fall of 0.4% to growth of 0.2%, as the negative impact of Europe’s energy crisis has been less severe than originally thought. Germany’s IFO Business Climate Index also rose to its highest level for seven months.
The UK bucked this trend with a weak composite PMI for January; the figure fell to 47.8, below forecasts and down from December’s 49.0. It marked the sixth successive month of contraction (below 50.0) and was the weakest figure for two years. The services sector weakened more over the month (49.9 to 48.0), while manufacturing improved but remained below the reading for services (45.3 to 46.7).
Canada’s central bank hikes but signals that the end is in sight; ECB remains hawkish
Canada’s central bank increased its benchmark interest rate by 25bp to 4.5%, in line with expectations, following a 50bp rise in December. More importantly, the Bank of Canada stated that this month’s rate hike should be viewed as the end of its recent period of aggressive monetary tightening, which has seen interest rates rise by 425bp in 10 months. This more dovish stance is dependent on an expected stabilisation in the economy and further easing of inflation. The ECB, by contrast, remains hawkish. In a speech during the week, ECB President Christine Lagarde reinforced the central bank’s current tough monetary stance by saying that the ECB would “stay the course” in keeping interest rates in “restrictive territory” to bring inflation back towards the 2% target. This followed earlier comments from the president of the Dutch central bank and ECB policymaker Knot, who suggested that the central bank was primed not only to raise rates by 50bp in both February and March but would need to continue raising rates beyond then.
Better than expected data supports equity markets and pushes US and European bond yields higher
A mild risk-on stance prevailed in equity markets, owing somewhat to continued hopes of a reduced pace in interest rate hikes and better economic data in the US and Europe. Investors largely looked through mixed earnings figures, including some notable earnings misses from US companies, Microsoft, Intel and Boeing. European markets were also buoyed by relatively better economic data, which was in contrast to the more subdued tone in the UK. Oil and most other industrial commodities – such as copper and iron ore – rose mildly, boosted by robust headline fourth-quarter US GDP figures and falling COVID cases in China. Conversely, natural gas in both the US and Europe continued to plummet, falling below one-year lows. Moves in government bond markets followed suit, with US and German government bond yields rising versus a flat environment in the UK. US yields face ongoing uncertainty around discussions on the debt ceiling.
Next week: Monetary policy decisions and company earnings likely to guide market action
Next week brings the Fed, the ECB and the BoE back in the spotlight as they deliver their latest monetary policy decision. The Fed's pace of hikes is expected to slow to 25bp, with the market potentially focussing on messaging around potential rate cuts and QT due to decelerating headline inflation and ongoing debt ceiling concerns. However, the ECB and BoE, are both expected to raise policy rates by 50bp at their next meeting on Thursday. Markets have lots of data to digest ahead of those decisions, with Eurozone Q4 GDP, inflation and labour market data all released earlier in the week. There is plenty of economic data releases in Asia next week including Japan’s labour market data and retail sales as well as China’s PMI data.
Corporate earnings continue, with Apple, Alphabet and Amazon – comprising more than 12% of the S&P 500 by market cap - reporting on Thursday.These announcements remain important to provide bottom-up insights into economic trends and cost-cutting initiatives that aren’t yet reflected in labour market reports. Other prominent companies in the energy, automaker, and healthcare industries are due to report, including Pfizer, Shell, Exxon Mobil, GM and Ford.
Summary
- The European Central Bank’s December minutes indicate a united and hawkish mindset towards inflation.
- Economic data was mixed over the week.
- US bond yields fell as a risk-averse mood prevailed in markets.
- UK inflation eases in December.
- Next week: Global PMIs and tech company earnings likely to guide market action.
Weekly review
The European Central Bank’s (ECB) December minutes indicate a united and hawkish mindset towards inflation
The ECB showed a steely determination to bring inflation under control and appeared to pour cold water over the market’s hope of a softer monetary policy stance. Several policymakers voted for a 75bp rise, worried that inflation had become too entrenched in the economy, although a 50bp hike was ultimately implemented. This hawkish tone was echoed by ECB President Christine Lagarde, who stated that “inflation, by all accounts and whichever way you look at it, is way too high”. Markets are currently pricing in a further 70bp of hikes, with an estimated peak rate of 3.2% by August. After falling at the beginning of the week, eurozone bond yields crept higher after the release of the ECB’s minutes.
Economic data was mixed over the week
Equity investors were jittery as disappointing economic data emerged, especially in the US, reigniting fears of recession. Both US retail sales and industrial production declined over December and were worse than expected. Additionally, there were several announcements of large-scale redundancies at bellwether firms such as Microsoft and Goldman Sachs, which added to the negative sentiment. In the US, technology stocks sold off, and the Nasdaq’s seven-day winning run came to an end. There had been some encouragement earlier in the week from improving German wholesale price, US producer price and UK consumer price inflation data. Additionally, Germany’s Economic Sentiment Indicator returned to a positive reading for the first time in almost a year. European and UK equities fell alongside the US market. Oil prices drifted higher on optimism about China’s post-COVID economic reopening and the country’s better-than-expected fourth-quarter GDP figures. Gold rose on widespread weaker economic data and hopes of reduced tightening by the Federal Reserve.
US bond yields fell as a risk-averse mood prevailed in markets
Treasury yields fell, with the 10-year yield falling from 3.5% towards 3.3%, its lowest level since September. The initial driver behind the dip was the producer price inflation figure for December, which showed the annual rate falling to 6.2% – below expectations, and behind November’s figure of 7.3% – as energy and food costs eased. It was the lowest figure since March 2021. The figure was down 0.5% for the month, marking the steepest monthly decline since April 2020. Later in the week, disappointing retail and industrial production data, showing worse-than-expected month-on-month falls in each case, reinforced the risk-off mood. The market expects the data to give the Federal Reserve added reasons to slow the pace of interest rate hikes; such a view was reflected in a further decline in the forecast peak Fed funds rate (expected in June 2023) to approximately 4.8%. Some parties remain hawkish, such as St. Louis Fed President James Bullard, who this week urged the Fed to stay the course and get rates above 5% “as quickly as we can” to prevent high levels of inflation from becoming entrenched.
UK inflation eases in December
The annual rate of consumer inflation fell in December to 10.5%, from 10.7% in November. The figure was in line with market expectations and mainly reflected a moderation in petrol prices. The cost of food and eating out at restaurants accelerated, however. Indeed, the cost of food and non-alcoholic beverages rose by 16.8% year on year, the highest growth rate for just over 45 years. Core inflation, which excluded energy and food costs, remained unchanged at 6.3%, but a little higher than expected. Gilt yields fell on the news but recovered somewhat later in the week. Despite some surprisingly dovish comments from Bank of England Governor Andrew Bailey on the likely path of inflation and interest rates, the market still expects the central bank to hold the pace of its tightening for longer than the Fed and European Central Bank.
Next week: Global PMIs and tech company earnings likely to guide market action
Next week, markets will focus on global growth when the Q4 US GDP and global PMI numbers are released. The PMIs on Tuesday will follow numerous encouraging data points for Europe, such as declining gas costs and upbeat predictions related to China's reopening. Although the Fed will be in its blackout period ahead of the February meeting, we will hear from several ECB speakers, including president Lagarde. There will also be a raft of data from the PCE, personal spending and durable goods orders, and consumer confidence in the Eurozone, Germany, Italy and France. Corporate earnings continue, and Microsoft will start the reporting season for 'Big Tech' on Tuesday. Still, all eyes will be on Tesla post-market the next day ahead of earnings from traditional automakers the week after as investors try to grasp trends for EV demand. Throughout the week, other prominent companies in the oil and healthcare sectors and major European corporations like LVMH, SAP, Volvo, and H&M will also report.
Summary
- US CPI falls, in line with consensus estimates; Fed speakers noted that the fight against inflation is not over.
- Markets reassured with “in-line” CPI print with equities and bonds both continuing to rally.
- Positioning: added exposure to cyclical assets fixed income and total return strategies remain attractive.
- Next week: Central bankers speak at Davos; BoJ meeting could provide an update on yield curve control; more corporate earnings.
Weekly review
US CPI falls in line with consensus estimates; Fed speakers note that the fight against inflation is not over
Following on from the decline in eurozone inflation last week, US inflation fell for the sixth month in a row. Annual consumer inflation came in at 6.5% in December, in line with market expectations. Headline inflation has fallen from its peak of 9.1% in June and is at its lowest level for 14 months. Easing fuel and energy costs were again the primary factor behind the lower number. Core inflation, which excludes energy and food, rose by 5.7%, the third successive decline in the series since a peak of 6.6% in September, and down from November’s 6% level.
Markets were also relieved that Federal Reserve Chairman Jerome Powell avoided making any substantive remarks about the direction of interest rates in a speech in Sweden during the week; instead he discussed central bank independence. Earlier in the week, however, two Fed officials (Atlanta Fed Chairman Bostic and Richmond Fed Chairman Barkin) both stated that the fight against inflation was not yet over, and that they fully expected interest rates to rise above 5% – where they could remain for some time – in order to ensure annual inflation falls back towards the 2% level favoured by the Fed.
Markets reassured with “in-line” CPI print with equities and bonds both continuing to rally
Global stock markets rallied on the consensus CPI print, as the recent pessimistic mood about the prospects of economic growth and higher inflation continued to subside. The FTSE 100 Index broke through its COVID-period ceiling to reach its highest level since early 2018, led by commodity-related and financials stocks; it was close to an all-time high in early trading on Friday. The Euro STOXX 50 Index rallied to a near 12-month high. Meanwhile, the S&P 500 also traded higher, led by technology stocks.
Bond market returns were also positive over the week, with market expectations for a 25bp hike at the next Fed meeting, rather than the previous pace of 50bp being maintained. Peak rates (anticipated in June) and end-2023 rates are predicted at just below 5% and 4.5% respectively. The 10-year Treasury yield fell c.10bp at the time of writing, to below 3.5%; close to recent December lows.
Next week: Central bankers speak at Davos; BoJ could provide yield curve control update; corporate earnings
Next week brings a number of key US economic indicators in the housing sector, with both NAHB index as well as housing starts and building permits. We will also see retail sales and industrial production numbers as well as the Fed’s beige book on Wednesday. It will, however, be a short week for US investors with both the US bond and equity markets closed on Monday for Martin Luther King Day. Both ECB President Lagarde and BoE Governor Bailey are expected to speak at the annual meeting of the World Economic Forum in Davos. The Bank of Japan is also due to meet next week, with the focus on its monetary policy decision and rhetoric around yield curve control, especially in light of the recent testing of the control levels by the market. In a data heavy week, we will also receive a raft of data from the UK, with inflation, labour market, consumer confidence, and retail sales data. We will also see the ZEW survey from Germany as well as PPI on Friday. Q4 GDP from China may also provide some insight as to its potential for a positive catalyst over the coming months.
Corporate earnings will also continue, with US banks such as Goldman Sachs and Morgan Stanley out, as are Netflix, Proctor & Gamble and Alcoa. Corporate profitability has been an important indicator historically for equity markets and remains one of the likely signposts to equity markets bottoming in our view.
Summary
- Eurozone inflation comes in below expectations, supporting local equity markets; but higher food prices evident in UK.
- US Federal Reserve minutes illustrate rate cuts unlikely until inflationary pressures ease; core inflation important.
- Positioning: equity markets remain vulnerable, fixed income and total return strategies more attractive.
- Next week: US CPI to take centre stage alongside European industrial production and UK GDP; earnings season begins.
Weekly review
Eurozone inflation below expectations supporting local equity markets; higher food prices evident in UK
The annual rate of inflation in the eurozone continued to decline from its October peak (10.6%), falling to 9.2% in December, aided by lower energy costs. Meanwhile, natural gas prices fell to levels last seen before the Russian invasion of Ukraine as warmer temperatures prevailed on the continent, further improving market sentiment.
That said, ECB rhetoric still pointed to higher policy rates, with ECB policy member Martins Kazaks suggesting that “at the February and March meetings, we will have significant rate increases”. Despite the still hawkish rhetoric, European equity markets rallied, and bond yields fell at the start of the year.
Inflation data releases in the UK were in stark contrast to those from Europe, with the price of food in supermarkets rising 13.3% year on year in December, according to data from the British Retail Consortium (BRC), the most since records began back in 2005.
US Federal Reserve minutes illustrate rate cuts unlikely until inflationary pressures ease; core inflation important
The recent rally in risk assets and fall in government bond yields has led to an overall easing in financial conditions, despite higher policy rates. The Fed’s December meeting minutes pushed back against this view, confirming a reluctance to ease up on higher rates while inflationary pressures were high. In contrast to market pricing, none of the policy group expected any lowering of interest rates this year, despite growing signs that headline inflation, at least, has peaked. While markets had been encouraged by statements from Fed Chair Powell that the pace of interest rate hikes will likely slacken this year, investors were left slightly disappointed by clear signs from the minutes that the Fed would need to keep interest rates higher for longer to tame inflation. The Fed seemed at pains to address any misunderstandings by the market, stating that it was “important to clearly communicate that a slowing in the pace of rate increases was not an indication of any weakening of the Committee's resolve to achieve its price stability goal".
Although inflation remains centre stage, the focus continues to shift towards more core measures of inflation. Over the coming months, the base effects from the sharp rise in commodity prices in Q1 2022 will push headline inflation lower. However, it is the core inflationary pressures, such as wages and the labour market, that will likely dominate the reaction function of central banks over the coming months. Recent labour market data in the US is not showing clear signs of slack, with stronger-than forecast ADP private job creation, lower initial jobless claims and above expected non-farm payrolls. Wage pressure data was mixed, with the average hourly earnings below expectations (0.3% versus 0.4% expected) yet the quit rate from the Jolts survey remaining high, typically resulting in employees changing jobs for higher wages.
Positioning: equity markets remain vulnerable, fixed income and total return strategies more attractive
An inflation shock initially drove markets in early 2022., before morphing into a rates shock over the year, as policymakers strived to control significantly above target levels of inflation. The market is now increasingly turning towards the likely growth implications of the rapid policy tightening, which is designed to keep inflationary pressures in check. Recent inflation data has been consistent with falling headline inflation which has, in turn, spurred hopes of more modest rate hikes and provided some relief to risk assets. This creates a paradox; easier conditions stimulate demand and maintains inflationary pressures (from margins and wages) higher.
Given we will likely have to see demand destruction flow through to lower corporate profitability at some stage, we remain unconvinced that equity markets are past the point of maximum pain. Bond markets, however, given the sharp rise in yields experienced in 2022, now offer more value, both in outright terms but also as an attractive diversifying asset to equity markets – a role they failed to fulfil last year given the nature of the shock. Investment grade credit and emerging market debt both offer attractive long-term value given higher yields and wider spreads. Commodities, by contrast, continue to come under pressure and are unlikely to benefit from an economic slowdown as it materialises. Total return strategies continue to offer an attractive offset to potential directional weakness in traditional assets.
Next week: US CPI to take centre stage alongside European industrial production and UK GDP; earnings season starts
Next week investors will likely focus on the December CPI print in the US, the last print before the next Fed meeting on 1 February and a particularly important print, given recent weaker than expected European inflation prints. Next week also sees the release of the University of Michigan consumer inflation expectations and sentiment indicators. In Europe, we will receive several industrial production and trade data updates from Germany, France and the wider Eurozone. Elsewhere, the UK’s November GDP will be released as well as Italian retail sales. Perhaps more importantly we will start the latest earning session, with several larger US banks such as JP Morgan, Citigroup and Bank of America all releasing earnings towards the end of the week. Corporate profitability has been an important indicator historically for equity markets and remains one of the likely signposts to equity markets bottoming in our view.
