Mood Swings in Markets

MARKETS MOOD SWINGS CONTINUE Financial markets remained volatile over the past week. The darker mood for risk assets eventually gave way to some optimism that the global economy may prove to be more resilient than previously expected. Global equities and government bond yields mostly rose, while both the pound and the euro continued to fall against the US dollar. The euro fell to new 20-year lows, closing in on parity against the greenback, while sterling declined below $1.20. Brent crude oil pared losses after falling below $100 a barrel. In the US, the June ISM services survey fell less than expected to 55.3, still in expansion territory, while the prices paid index remained elevated despite edging down in the past two months. Nonfarm payrolls grew by 372k in June and the unemployment rate stayed at 3.6%, confirming a return to pre-Covid levels. Annual wage growth edged down to 5.1%. The US labour market appears to be cooling but it remains very tight. The minutes of the Fed’s June policy meeting reaffirmed that interest rates will rise further, with another 75bp increase to 2.25-2.50% on the table for the next announcement later this month (27 July).

BOE WILLING TO MOVE FASTER ON RATES

In the UK, market reaction to the domestic political turmoil resulting in Boris Johnson’s resignation as Prime Minister was limited. The June services PMI was revised up to 54.3, although the future output index declined for a fifth consecutive month to the lowest since May 20I20, while price indicators remained near record highs. Semiconductor shortages resulted in a 24.3%y/y fall in new car registrations. The Bank of England’s Chief Economist and MPC member, Huw Pill, said that he is open to a larger 50bp hike at the next meeting. The Bank’s ‘Decision Maker Panel’ survey of businesses revealed a further rise in inflation expectations compared with the last report in May. Elsewhere, contributing to downward pressures on the euro, Germany recorded a deficit in its goods trade balance for the first time since 1991 mainly resulting from sharply higher imported energy costs, especially after Russia’s invasion of Ukraine. Minutes of the ECB’s June meeting reaffirmed a likely 25bp hike later this month and a possible 50bp rise in September. In China, the Caixin services PMI returned to expansion territory in June, rising to 54.3, after Covid restrictions were eased.

UK GDP TO POST FIRST RISE SINCE JANUARY

In the coming week, the UK Conservative Party’s 1922 Committee of backbench MPs is expected to elect a new executive on Monday. The Committee is then expected to confirm the process for selecting a new permanent leader of the Party who will be invited to form a government by the Queen. The current process is that Conservative MPs will whittle down the candidates to two and the winner will be chosen by the wider party membership. Reports suggest the aim is to have a new leader in place by early September. The UK will publish monthly GDP figures for May (Wed). The economy expanded by 0.8%q/q in Q1 owing to a strong start to the year. Output, however, stagnated in February and contracted in March. Another decline in April of 0.3% means that Q2 started off on the back foot. The data for May and June are likely to be more difficult to interpret because of the statistical effect of the Queen’s Platinum Jubilee in June. We forecast GDP to rise by 0.5% in May, helped by an extra working day as one of the month’s bank holidays was shifted to June. That may result in solid monthly rises for manufacturing and construction output of 1.0% and 2.0%, respectively, and a more moderate 0.3% increase for services. Experience from the Golden (2002) and Diamond (2012) Jubilees suggests that output will probably then be down sharply in June. It means that Q2 growth overall will probably be negative but is likely to then rebound in Q3. However, even with that bounce, underlying economic growth will probably still be weaker than at the start of the year.

US INFLATION WILL REMAIN HIGH

In the US, the coming week sees the release of CPI (Wed) and PPI (Thu) inflation data for June. We expect annual headline CPI to rise again to 8.8%, a new fourdecade high reflecting rising energy and food prices. Annual core inflation is expected to ease for a third straight month to 5.8%. Base effects, however, mean that annual core CPI could pick up again in Q3 to offset any downward pressures on headline inflation if the recent fall in the oil price is sustained. PPI inflation is likely to remain elevated, suggesting that there are still substantial cost rises in the pipeline. Given recession concerns, there will be a lot of interest in the activity data including retail sales and industrial production for June (both Fri). We expect retail sales to bounce back after a surprisingly weak May outturn and a further rise in industrial production. Downside surprises will not stop the Fed from tightening policy further later this month, but it may mean that they would need to acknowledge that there are signs growth is weakening and potentially by more than expected. We also forecast no change in the University of Michigan consumer sentiment index (Fri) at 50 which is already a very weak level. The survey’s inflation expectations data will be closely watched. In the rest of the world, Chinese Q2 GDP (Fri) is forecast to weaken because of Covid lockdowns in Shanghai and other cities. Nevertheless, the monthly data are expected to show recovery through the quarter. The Reserve Bank of New Zealand (Wed) is expected to hike again by 50bp to 2.5% to combat inflation. The Bank of Canada (Wed) is predicted to raise rates possibly by 75bp to 2.25%. Eurozone data include industrial production (Wed) and the German ZEW survey (Tue).

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