Inflation Angst

US equities fell for a fifth straight day on Friday enduring their worst week since June.  Asian markets faced a tough start to the week after US losses and amid further Chinese regulatory measures, with Alipay in focus as regulators are reportedly (FT) looking to break it up while the Biden administration is reported to be looking at starting a new probe into Chinese industrial subsidies.  Worries about the persistent impact of the Delta variant on the services and tourism sector globally are adding to the sense of malaise in markets. 

Data wise, US Aug Producer Price Index (PPI) data dented confidence following a bigger than expected 0.7% m/m, 8.3% y/y increase, with yet more evidence of the impact of supply pressures impacting the data even as the core measure slowed.  It is worth noting that China’s outsized increase in PPI inflation in August released last week sent a similar message.  Such fears may have been attributable to the move in bonds, with US Treasury yields rising on Friday, giving back the gains in the wake of the strong 30- year auction, despite the fall in equities. 

Following the US PPI, there will be a number of other releases this week which could potentially add to nervousness over lingering inflation pressures.  The plethora of inflation data kicks off with India’s August consumer price index (CPI) today for which a 5.6% y/y increase is expected, a level which will likely continue to make India’s central bank (RBI) uncomfortable.  US August CPI scheduled for tomorrow is likely to show another strong rise in food and energy prices though core CPI likely rose at its slowest pace since February.  Canada August CPI (Wed) is likely to drift higher while UK August inflation (Wed) is likely to reveal a jump after a sharp decline last month.  On balance, the inflation releases this week will do little to calm market’s inflation fears.

Other key data this week will likely show weakening activity.  The slate includes US August retail sales (Thu). The data is likely to add to evidence that the boost to goods spending in the US from fiscal stimulus has peaked.  China activity data including August retail sales and industrial production (Wed) will likely show further moderation especially to retail sales which was likely impacted by lockdowns in various provinces.  Australia employment data (Thu) is likely to have revealed a decline while NZ GDP (Thu) is likely to show firmer economic momentum than the RBNZ’s forecast.

Weaker China data and Delta Concerns

The same old discussion continues to afflict equity investors as lofty valuations balance against a wall of liquidity.  So far liquidity is winning out as US equity indices are trading around record highs despite a surprise 13.5% plunge in August US consumer confidence released last Friday, which marked one of the largest declines ever in the University of Michigan series. In fact confidence fell to a level even below the COVID low, likely due to Delta variant concerns. 

The confidence data fuelled a bull flattening in US Treasuries and USD sell off.  As reflected in the confidence data, the Delta variant is increasingly threatening recovery and evidence of sharply rising virus cases even in highly vaccinated countries sends a worrying sign of what to expect going forward. 

Geopolitics will be in focus after the Taliban effectively took over Afghanistan after marching into Kabul yesterday.  This will have major repercussions in South Asia and the rest of the region.  Separately, Canada’s PM Trudeau has called a snap election on Sep 20 while Malaysia’s PM Yassin has resigned today.  Geopolitics, weak US confidence data, China’s regulatory crackdown and ongoing Delta variant concerns, with Philippines and Thailand registering record virus cases in Asia led to a cautious start to the week for Asia. 

Further direction came from China’s July data slate released today.  The data revealed weaker than expected outcomes across the board, with industrial production and retail sales alongside other data revealing further softening.  The releases provided more evidence that Chinese consumer caution has intensified in the wake of targeted lockdown measures in several provinces while industrial activity is being hampered by supply constraints and weakening demand for exports.

The Chinese data will likely provide more support to expectations of further easing in liquidity from the central bank (PBOC) and even policy rate cuts. Separately, China’s regulatory crackdown has extended further, weighing on Chinese and regional assets, but there is little sign that officials are looking to step back.   More broadly, weaker Chinese data will likely contribute to a near term tone of risk aversion afflicting global market sentiment amidst worsening Delta variant concerns, rising growth worries and geopolitical risks.

Over the rest of the week Fed FOMC minutes (Wed), in particular views on the shape of quantitative easing tapering, as well as central bank decisions in New Zealand (Wed), Indonesia (Thu) and Norway (Thu) are in focus.  The RBNZ is likely to be the most eventful among these, with a 25bp hike in its policy rate (OCR) expected amid firming data and rising inflation pressures.  Key data this week includes US July retail sales (Tue), with falls in both the headline and control group readings likely as the boost to spending from stimulus and reopening fades. 

Crypto Volatility

It was a calmer end for stock markets in a volatile week but crypto was not so fortunate after China’s State Council repeated its warning about Bitcoin mining and trading as central banks appear to be increasing their scrutiny of crypto at a time when many of them are introducing their own digital currencies.  Concerns over increased regulations, especially in China where the bulk of Crypto mining takes place, taken together with ESG issues as focus turns to the environmental costs of mining crypto, threaten to do more damage.  Volatility continued over the weekend, with Bitcoin and other crypto undergoing sharp moves.  Crypto volatility threatens to find its way into other markets, with for example, US equities positively correlated to moves in crypto while the US dollar (USD) could benefit.

There was at least a little relief for markets in terms of inflation angst, with market inflation measures (breakevens) falling while commodities, another factor fueling inflation fears, continued to come off the boil. It seems that the Federal Reserve’s dovish message may finally be sinking in even as the Fed FOMC minutes noted that they are planning on discussing tapering at some point, rather than previously not even thinking about thinking of tapering. US Treasury yields have been capped amid the cooling in inflation fears while rate sensitive equities, especially Tech are likely to find some solace.  The USD has struggled over recent weeks but the recent rise in real yields will likely offer some support. 

There was yet more evidence that the US economy is powering ahead, with measures of manufacturing and services sentiment as reflected in Markit purchasing managers indices (PMIs), rising to record highs as fiscal support and an improving COVID-19 outlook continue to boost optimism. While US economic data has been strengthening, markets have become accustomed to positive US releases and therefore any reaction is likely to be more muted.  Indeed, the Citi Economic Surprise Index, a measure of US data relative to expectations, is near its lowest since June 2020. 

This week is relatively light on the data front.  The key US data release is the Personal Consumption Expenditures (PCE) report, something that the Federal Reserve looks at closely, on Friday; consensus expectations are for a 2.3% quarter on quarter (q/q) increase in core PCE in Q1.  A number of Fed speakers will also be on the wires and their comments will be scrutinized on any further elaboration on “discussing a plan” on tapering.  There will also be a few central bank decisions including in Hungary (Tue), Indonesia (Tue), New Zealand (Wed), and Korea (Thu).  No changes are likely from any of these central banks.

Lingering Disappointment

Another soft close to US stock markets at the end of last week sets up for a nervous start to the week ahead.  The S&P 500 has now declined for a third straight week, with tech stocks leading the way lower as more froth is blown way from the multi-month run up in these stocks.  Lingering disappointment in the wake of the Federal Reserve FOMC meeting is one factor that has weighed on risk assets.  More details on how the Fed plans to implement its new policy on average inflation targeting will be sought. Markets will also look to see whether the Fed is pondering any changes to its Quantitative Easing program. This week Fed officials will get the opportunity to elaborate on their views, with several Fed speeches in the pipeline including three appearances by Fed Chair Powell. 

Disappointment on monetary policy can be matched with a lack of progress on the fiscal front, with hopes of an agreement on Phase 4 fiscal stimulus ahead of US elections fading rapidly.  A loss of momentum in US economic activity as reflected in the NY Fed’s weekly economic index and declining positive data surprises as reflected in the Citi Economic Surprise Index, are beginning to show that the need for fresh stimulus is growing.  On the political front, the situation has become even more tense ahead of elections; following the death of Supreme Court justice Ruth Bader Ginsburg attention this week will focus on President Trump’s pick to replace her, adding another twist to the battle between Democrats and Republicans ahead of the election.    

Another major focal point ahead of elections is US-China tensions, which continue to simmer away. China’s economy and currency continue to outperform even as tensions mount.  August’s slate of Chinese data were upbeat and China’s currency (CNY) is increasingly reflecting positive economic momentum, with the CNY CFETS trade weighted index rising to multi week highs.  There is every chance that tensions will only get worse ahead of US elections, likely as the US maintains a tough approach in the weeks ahead but so far Chinese and Asian markets in general are not reacting too much.  This may change if as is likely, tensions worsen further. 

After last week’s heavy slate of central bank meetings, this week is also going to see many central banks deliberate on monetary policy.  The week kicks off with China’s Loan Prime Rate announcement (Mon), followed by policy decisions in Hungary and Sweden (both Tue), New Zealand, Thailand, Norway (all on Wed), and Turkey (Thu).  Markets expect all of the central banks above to keep policy unchanged as was the case with the many central banks announcing policy decisions last week.  The lack of central bank action adds further evidence that 1) growth is starting to improve in many countries and 2) the limits of conventional policy are being reached.  While renewed rounds of virus infections threaten the recovery process much of the onus on policy action is now on the fiscal front. 

A Host Of Global Risks

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

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