Week ended July 15th 2022
Updated: Jul 17, 2022
US inflation blazing, Eurozone in disarray
SUMMARY OF MARKETS
It was another down week for global equity investors although at least the week ended on a positive tone with up-sessions on Friday in the US and Europe. This feels positive especially considering the news flow this week. The US had an above-consensus inflation read for June, large US banks started earnings season with mixed results, and there was turmoil in the Eurozone involving Italy’s political leadership. Even though the first half of July has been a mixed bag, it actually feels rather positive given the dismal performance of traditional financial assets in the first half of the year. Make no bones about it – we are starting the second half of this difficult year with very beaten-down expectations.
There was more telling information in the performance of the US Treasury curve this week than in equities. The 2y-10y UST yield curve inversion seems to have legs with the differential widening to –20bps by the close on Friday. Yields at the short-tend of the curve rocketed upwards whilst yields at intermediate and longer-maturities decreased, a harbinger according to many economists that a recession is looming Stateside. A 9.1%/annum CPI read in the US for June, released on Wednesday, was the culprit, at least as far as pushing yields at the very short end of the curve higher. A 75bps increase in the Fed Funds rate at the July 26-27 FOMC meeting has become a near-certainty, with some pundits even suggesting there might be an unprecedented 100bps increase ahead (which I doubt).
The higher-than-expected CPI read undoubtedly reinforced the Federal Reserve’s resolve to remain on its hawkish course, which is continuing to cause the US Dollar to strengthen. As the USD:EUR exchange rate approaches parity, the ECB seems completely devoid of a plan to address high inflation and potential fragmentation within the Eurozone sovereign debt market. The Eurozone has been pushed further into crisis mode by the “attempt” of Prime Minster Mario Draghi to resign on Thursday, an unresolved situation as his coalition crumbles. Italy is the Eurozone’s second-most indebted country and one of its slowest growing.
Even though oil clawed back some losses as the week wore on, WTI crude still closed down 6.9% W-o-W at $97.59/bbl . I really see nothing particularly encouraging about supply, so the weakening price must reflect a future expectation of decreasing demand as the global economy slows. Oil is not alone in this respect, as many other commodities have come sharply off of their highs, also fitting in nicely with the “recession is coming” narrative. The stronger USD is playing a role, too, as many commodities and precious metals linked to the US Dollar fall as the greenback strengthens. Gold has also drifted lower with subsiding inflationary expectations (as bizarre as that might sound at the moment) and a strengthening US Dollar. Bitcoin has stabilised after falling below $20,000 early in the week, welcomed by cryptocurrency investors. However, in my opinion the collateral damage is far from over as the crypto bubble continues to deflate.
Corporate credit spreads also (re)widened after tightening last week, as credit concerns continue to bubble in investors’ minds even if higher defaults or indications of stress are not yet clearly visible in the market. USD-denominated investment grade (BBB) and high yield credit spreads have widened by 80bps and 243bps, respectively, since the beginning of the year, and EUR-denominated high yield spreads have widened by 307bps. Credit has tightened and will continue to do so for the foreseeable future. Lastly, earnings season kicked off with four of the six largest US banks reporting results, and it was a mixed bag. Not surprisingly, all are suffering from lower investment banking revenues as capital markets and M&A activity subsides.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
US CPI and retail sales
The BLS release for June CPI is here. Inflation was 9.1% Y-o-Y in the US in June, the highest rate since 1981. Retail sales for June, released on Friday by the Commerce Department (here), reinforced strong consumer demand even as the Fed embarks on its hawkish path. Retail sales increased 1.0% (nominal) in June, recovering after a 0.1% decline in May (vs April). Even with this strong retail sales data, tighter monetary policy will kick-in hard before we know it, and this will reduce consumer spending and overall demand, especially for services.
Italian prime minister Mario Draghi tries to resign
If the Eurozone didn’t have enough to worry about as the Euro plummets and the ECB tries to figure out what to do, prime minister Mario Draghi submitted his resignation to Italy’s president on Thursday as his weak coalition crumbled. Without a working coalition, the government will be unable to get anything done. This is coming at a particularly precarious time for Italy, the second highest indebted country in the Eurozone (around 150% debt-to-GDP), as the country’s 10y BTPs (Italian bonds) closed 202bps wider than the benchmark 10y German bund. This puts a straight-jacket on the ECB as far as raising rates to address increasing inflation in the Eurozone, unless it reintroduces some sort of modified QE programme to support bonds of the weaker countries in the Eurozone. It all sounds so 2011-2012 déjà vu to me. Bank earnings
JP Morgan (JPM, –0.9% W-o-W), Morgan Stanley (MS, +1.7%), Wells Fargo (WFC, +2.4%) and Citibank (C, +6.8%) all released earnings this week – as is customary – to kick-off earnings season for S&P 500 companies. Goldman Sachs and Bank of America will release earnings on Monday. The numbers were fairly good vis-à-vis consensus expectations, although all of the banks’ earnings were lower than the same quarter in 2021. This is not surprising given that capital markets (new issue) and advisory business in the market overall is running at a much lower clip than for the same period of 2021. All four management teams mentioned that the outlook for the US economy remained strong (meaning consumer demand) although they highlighted global headwinds like inflation and the war in Ukraine. JPM also stopped their stock buyback programme, indicating their concern about the future. All four banks increased their credit provisions. You can find the weekly earnings update for the S&P 500 from @refinitiv here. The forward P/E ratio of the S&P 500 has now declined to 15.8x, improving attractiveness of stocks and pricing the index appropriately perhaps for the uncertainty ahead.
China’s (weak) 2Q22 growth
China’s National Bureau of Statistics released 2Q22 GDP growth for China mid-week (here), which came in at a dismal 0.4%. Growth for 1H2022 vs 1H2021 was 2.5%. China, largely considered one of the world’s key growth engines, has suffered from a series of COVID-related shutdowns over the last several months, and this has clearly caused its economy to stall. Slower-than-expected growth in China is another reason that the world is likely staring at a recession in the coming quarters.
Here is some of the key data and dates on which to focus.
Earnings: 72 more S&P 500 companies report earnings this coming week (week of July 18th), including Netflix, JNJ, United Airlines, Twitter, Tesla, AT&T, Philip Morris and American Express;
FAMAG 2Q22 earnings releases are: GOOG 7/25; MSFT 7/26; META (Facebook) 7/27; AAPL 7/28; and AMZN 8/4;
Economic data: Inflation (CPI) for the UK released Wednesday; BoJ and ECB policy statements, Japanese CPI and US jobs report released Thursday; and UK retail sales and PMI data for the US, UK, Germany, France and Eurozone overall released on Friday;
The Governing Council of the ECB will meet on July 21st; and
The next FOMC meeting is July 26th-27th.
Safe haven and other assets
Corporate bonds (credit)