Week ended August 5, 2022
BoE bumps rates, US jobs surprise
SUMMARY OF MARKETS
August started well for equity and bond investors, at least until Friday when the US jobs report for July was released before markets opened and surprised wildly on the upside. US equities quickly gave back their gains plus more in the pre-open futures market, and US Treasuries tanked as yields skyrocketed, especially at the short end of the curve. It is clear now that the increases in the Federal Funds rate have done little, at least so far, to dampen economic growth, a pre-requisite for getting run-away inflation in the US (and in the UK and Eurozone) under control. The strong jobs report caught investors wrong-footed, as yields headed sharply higher, the yield curve became more inverted, the US Dollar regained its mojo and tech stocks (most interest rate sensitive sector) tanked. With the two-year UST yield spiking 23bps yesterday following the release of the jobs report, the bond market is sending clear signals once again to the Federal Reserve to do more and do if faster before inflation becomes worse (see “Is the bond market doing the Fed’s dirty work?”, Oct 20th, 2021).
Not to be lost in the noise of the US jobs report, the U.K. clearly has its own problems which were laid bare on Thursday when the Bank of England released its Monetary Policy Summary. The Bank of England raised the Bank Rate 50bps, the sixth consecutive rate raise and the largest single incremental increase since 1995. This follows the 50bps increase in the similar rate by the ECB and the 75bps increase by the Federal Reserve in July, with all three central banks battling severe inflation in their respective economies. Along with the rate rise, the Bank of England provided a dire outlook for the UK, saying that inflation could go as high as 13% by the beginning of the fourth quarter and that the UK economy would contract in the fourth quarter and in 2023. Governor Andrew Bailey pulled no punches in his press discussion, even as one of the two candidates to be the next Prime Minister of the UK – Liz Truss – babbles on about ending the bank’s independence.
In some ways, the difference in forthrightness by the Federal Reserve and the Bank of England fairly depicts the difference between the way Brits and the Yanks approach bad news. Mr Bailey put it all out there, painting what is likely (or hopefully) a worst-case scenario, setting low expectations such that even slightly-better-than-expected economic growth could make him a hero. Mr Powell and his American colleagues take a different tact, downplaying time and time again what I think lies ahead – sharply slower growth or even a recession – seeming to not quite be able to come to grips with this reality. I appreciate the optimism, but the markets – or at least the bond market – is suggesting something very different in spite of the strong jobs report for July as the yield curve inversion deepens. Meanwhile, inflation continues to surge in both countries, far from under control in spite of hawkish policy action (albeit late in retrospect) and continuous rhetoric reminding investors that the only thing that really matters at the moment is to bring down inflation. “Conservative pessimism” vs “aspirational confidence” perhaps might be the best way to describe the different approaches between the BoE and the Fed for the same nagging problem – raging inflation.
Even with the strong jobs report, US equities bounced around most of the day on Friday, with the tech-heavy NASDAQ Composite not surprisingly being the poorest performer. In other global equity markets, Chinese stocks have been on a run in the wrong direction. It might be convenient to conclude that Ms Pelosi’s trip to Taiwan rattled Chinese equities, but the fact remains that the Chinese economy has plenty of problems of its own which have contributed to the Shanghai Composite index sliding over 5% since hitting its high just one month ago whilst the other global equity markets I track have staged solid recoveries.
One of the best indicators of market inflection points can be primary (new issue) activity in the corporate bond market. The 1H2022 had ugly returns in both investment grade and non-investment grade corporate debt (negative 13.9% and negative 14.0%, respectively), but as with equities, the tone improved markedly starting in July with the corporate bond market recording solid gains. Because of the poor backdrop in the first half of the year, it has been a relatively quiet new issue (primary) market this year. However, on Monday, Apple (AAPL) emerged from the shadows to sell $5.5 bln of bonds in four parts (7, 10, 30 and 40 years – see here), which looks damn smart at the moment following Friday’s spike in yields. New issue activity overall has picked up recently to satisfy increasing appetite amongst fixed-income investors. There were also a slew of corporate earnings releases this week, with the global energy giants continuing to impress (BP), European banks being generally solid, and US technology firms mixed. Overall, it was good enough to avoid any deterioration in sentiment around global equities more generally. Cryptocurrencies seem to have stabilised for now after clawing back some of their 1H22 losses, and gold has continued its steady albeit somewhat erratic rise from its post-pandemic lows reached a few weeks ago.
Increasingly, some well-known writers and investors – including yours truly – are wondering how the market has found such firm footing in the past few weeks given the rather pessimistic global economic outlook. I suggest checking out John Authers’ article in Bloomberg Opinion from Thursday entitled “Are Animal Spirits Running into a Dumb Money Trap?”. In addition, famed investor Michael Burry (called the real estate bubble that led to the GFC) tweeted the following on Thursday:
“The Silliness is back. After 1929, after 1968, after 2000, and after 2008, the strain of Silliness that transformed bulls into bubbles completely and utterly disappeared. But that familiar COVID-level Silliness is not dead yet. Like 2001 before Enron, before 9/11, before WorldCom.” [from Twitter, here]
I certainly can’t figure this rally out, although I’m pleased its happening. I just don’t believe it is sustainable, and I stand by my levels for the S&P 500 (3,700 – 4,100).
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
On Friday, the BLS released the payrolls report for July (here). 528,000 jobs were added in July, more than double economists’ consensus expectations, and the unemployment rate fell modestly to 3.5%, the same level as before the pandemic (February 2020). US stocks and bonds tanked on this news because it suggests that the Federal Reserve will remain firmly on its hawkish path. Earlier in the week, the so-called JOLTS (“Jobs Opening and Labor Turnover Survey”) released by the BLS (here) showed that new job openings decreased in July. Even so, with 5.7 million unemployed Americans and 10.7 million job openings, this means that there are 1.9 jobs for every unemployed person in the US!
Bank of England goes big
The Bank of England released its Monetary Policy Summary on Thursday (here) and raised the Bank Rate by an additional 50bps, its sixth consecutive increase, to 1.75%. The BoE also said it will stop reinvesting proceeds of maturing Gilts and will begin to unwind its corporate bond portfolio in September (“quantitative tightening”), another step towards tighter monetary policy to address stubbornly high inflation in the UK. The policy statement said that inflation is expected to peak at 13% in 4Q2022, and that the UK economy will slip into a recession in the fourth quarter and that growth will also likely contract in 2023.
Global economy slows
Signs of a slowing global economy are everywhere. The National Bureau of Statistics of China released PMI data for July on Monday (here), which showed that the Chinese manufacturing sector unexpectedly shrunk in July. US manufacturing data was largely mixed.
OPEC+ stands firm
OPEC+ met on Wednesday, and in spite of US President Biden’s visit to Saudi Arabia a few weeks back, the cartel did not deviate from its production quotas for the months ahead. The press release from OPEC+ is here. The surprising decision did not provided no support to oil prices, which continued to tumble, down a further 10.2% this week as fears of an economic slowdown overwhelm “supply constraints” in the global oil market.
Here is some of the key data and dates on which to focus.
Earnings are winding down, with only 23 S&P 500 companies reporting earnings this week (week of Aug 8th), including a few well-followed names like COIN, RBLX, CPNG, DIS and RIVN. The Lipper Alpha Refinitiv (LSEG) report for the week ended August 5th 2022 is here.
Limited economic data is coming week, but the big releases will be US CPI and PPI for July (on Aug 10th and 11th, respectively), June / 2Q22 GDP for the UK (Aug 12th), and the Michigan Consumer Sentiment Index (Aug 12th)
Corporate bonds (credit)
Safe haven and other assets