Week ended Sept 16th 2022
From bad to worse
“Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S.” said Raj Subramaniam, FedEx Corporation president and chief executive officer [press release here]
It was all looking so positive on Monday as the week started, with global equities following Friday’s positive session (S&P 500 +1.6%) with another strong session (S&P 500 +1.1% on Monday). And then….BOOM….along came a hotter-than-expected August CPI read in the US on Tuesday morning, causing US stocks and bonds to tank, dragging global stocks and bonds down with them as the week wore on. I found the drop on Tuesday overdone in isolation, but it has to be considered in the context of the sharp runup in US equities since September 6th (S&P 500 +5.2% in only four sessions), arguably equally silly. As far as the inflation read, a 0.1% CPI MoM increase isn’t very severe and only a modest increase from the nil M-o-M increase in July. Nonetheless, CPI moved the opposite direction from consensus expectations, and this has most certainly buried any thoughts of a more benign 50bps increase in the Fed Funds rate at the FOMC meeting next week. A 75bps increase is certainly baked in now, fair enough but largely expected anyhow. The more troubling issue that is rattling markets is the fear of “higher inflation longer” and the hawkish monetary policy that will be required to subdue this. Naturally, this concern extends further out than this week’s FOMC meeting, with pundits now debating the magnitude of rate hike at the subsequent FOMC on November 1-2 and beyond.
On top of the higher-than-expected US CPI read this week, markets were forced to digest:
poor retail sales in the UK for August,
on-going issues with natural gas supply in Europe and a proposal for a windfall tax on European (non-natural gas) energy companies,
mortgage rates in the US exceeding 6% for the first time since 2008, and
an earnings miss from economically-sensitive FedEx which also announced that it was withdrawing guidance for 2023 due to the highly uncertain global economic outlook.
In aggregate, this confluence of bad news completely overshadowed any positive effects from a potentially highly disruptive US rail strike this weekend had was fortunately averted. This – and any other positive news (if there was any) – was simply noise, as sentiment shifted and down we went!
Global financial markets were very poor this week, as you might surmise. Higher yields in government bonds are just a continuation of what we have been experiencing, and this spilled into equities causing a sharp sell-off globally. The US yield curve (re)steepened suggesting that economic growth is likely to stagnate eventually, and the price of gold fell, perhaps also indicating that longer term, inflation will be addressed albeit at a severe cost in terms of economic growth. Corporate bond spreads widened, more perversely in USD high yield as might be expected even though month-to-date losses have been more severe in the yield-sensitive investment grade arena. Not surprisingly, cryptocurrencies got hammered along with other risk assets as investors ran for cover. Overall, there was simply no place to hide as you can see in the summary table below (full detail in "Tables" section).
Overall, the feeling here in London is rather quiet and sombre as people await the funeral of HM Queen Elizabeth II on Monday. It is perhaps fitting given the dire outlook that the UK is facing at the moment. Sterling – a good indicator of how sour folks are at the moment regarding the UK economy – had weakened to $1.142/£1.00 by the end of the week. Indeed, US Dollar strength continues to be a barometer of the relative outlook for the US economy vis-à-vis the UK and Eurozone economies. As central banks in most part of the world tighten the screws to address stubborn inflation, the Bank of Japan is sticking with its yield curve management even though investors are running from the Yen. If this weren’t enough to push the US Dollar higher, the greenback also caught a risk-off bid this week. A strong US Dollar is the result of global economic imbalances, and it is neither sustainable nor good for the global (or US) economy.
Even with the horrible performance this week of most financial assets, I suspect this sell-off has – or will – get overbaked because runs this sharply one way or the other always do. In this risk-off environment with an increasingly cloudy economic outlook ahead, the pandemic mantra of “cash is trash” is being turned on its head. Cash has certainly outperformed traditional asset classes this year and is in fact probably one of the best performing asset classes YtD, as shocking as that reality might have seemed at the beginning of this year.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
US CPI misses vis-à-vis expectations
As mentioned in the “Summary” section, the problems in risk markets started early in the week when US CPI for August missed consensus expectations, which were for a decline of 0.1% MoM / 8% YoY. In fact, CPI increased 0.1% MoM in August (vs nil in July), and to 8.3% YoY (vs 8.5% YoY in July). You can find the BLS press release for August CPI here. More problematic and concerning to investors is that core inflation (ex-food, -energy) increased sharply in August to 0.6% MoM (6.3% YoY), from 0.3% in July (5.9% YoY). This inflation data suggested that there is much more work to be done by the Federal Reserve and certainly buried any hopes that the Fed might only raise the Fed Funds rate 50bps at this week’s upcoming FOMC meeting.
UK unemployment, CPI and retail sales point to consumers under pressure
In the UK, the labour market remains very tight, not dis-similar to the US and EU. Unemployment for the quarter ended July 31 decreased to 3.6% according to ONS data (here). This was the lowest unemployment rate in the UK since 1974. However, it is worth noting – and the same is true in the US and Eurozone – that the unemployment rate is being influenced not only by workers returning to work (the numerator), but also by people leaving the workforce completely (the denominator), making it dangerous to read too much into headline unemployment.
CPI fell in the UK in August, from 8.8% YoY in July to 8.6% YoY in August (ONS release here). As we found out towards the end of the week, retail sales took a tumble in August, down 1.6% compared to July. For comparison, UK retail sales increased 0.4% MoM in July. Together, declining retail sales and slightly lower CPI suggest that the UK consumer is under increasing stress, a situation that is almost certain to worsen as the Bank of England raises interest rates so as to ensure that inflation does not become anchored at these historically high levels. A UK recession is coming. and in fact, I suspect we are in it now. The operative description until this plays out is “stagflation.”
FedEx miss and withdrawal of 2023 forward guidance
Were FedEx not such an indicator of global economic activity, perhaps no one would have cared about their top- and bottom line 1Q2023 miss and their decision to withdraw guidance. The company’s decision to not provide 2023 guidance very much reflects the uncertainty that global giants like FedEx, and many others, face in the quarters ahead. I suspect that this might be the first of many companies that are uncomfortable saying too much about future earnings given all of the unknowns and risks that are before us at the moment.
Real estate is likely to be the next shoe to drop – 30y US mortgage rate rises above 6%
Freddie Mac announced that the average rate on a US 30-year mortgage rose above 6% for the first time since 2008. I have little doubt that the next shoe to drop will be US real estate, and the collateral effects into the broader economy are likely to be more perverse than is the current decline in equities and bonds.
You can find the Freddie Mac press release from Thursday here.
EU tax on energy companies
Whereas the UK proposal from PM Liz Truss is to cap consumer utility bills, the European Commission has gone one step further and has proposed a windfall tax on non-natural gas energy companies and utilities which would raise €140 billion, to be funnelled back to consumers and businesses. I never like this sort of thing because it results in distortions in the economy, but it will be a politically popular proposal given the sharp increase in energy prices in Europe this year.
Below are some of the key data releases and other financial events that matter for the week ahead. Most investors will be laser-focused on policy meetings for the Fed, the BoJ and the BoE, not so much for the expected rate rises that are largely telegraphed, but for the commentary alongside the rate decisions and press conferences that will follow.
HM Queen Elizabeth’s funeral will be at Westminster Abbey on Monday, September 19th, which King Charles III has announced will be a Bank Holiday (and markets will be closed in the UK)
Upcoming central bank meetings (current bank rate and expected increase at policy meeting is in brackets):
Federal Reserve – September 20-21 (2.25%-2.50% now, consensus +0.75%)
Bank of England – September 22 (1.75% now, consensus +0.50%)
Bank of Japan – September 21-22 (-0.1% now, no change expected)
Corporate bonds (credit)
Safe haven and other assets