WEEKLY: Big week ahead, CPI and central bank meetings

Week ended Dec 9, 2022

[SKIP THE COMMENTARY AND GO STRAIGHT TO THE TABLES]

SUMMARY

Compared to the week before when risk investors were duped once again into believing that there might be a possible Fed pivot, this week turned out to be slightly less eventful. However, the economic news and direction of markets based on the “latest read” remained mixed day to day. Let’s start by looking at equities. US stocks started the week on the wrong foot, then managed to stabilise mid-week before faltering again, ending the week with a classic last-hour fade which resulted in the S&P 500 losing 3.4% for the week. With all of the volatility in equities, it’s the bond market which tends to be the “grown-up in the room” (as I wrote last week and on Twitter Friday), providing more intelligent information about where we might be heading as this year draws to a close and we start to think about 2023. Although the bond market sold off on Friday, the yield on the 10-year US Treasury is still down 68bps since its cycle-high close of 4.25% on October 24th, and the yield curve is hovering near its steepest inversion in over 40 years (-76bps). Bond investors are more emphatic and less wishy-washy, signalling that

• the Fed has more work to do as far as inflation, and it will be a long battle, and

• there will be a cost to curbing inflation in terms of slower economic growth, perhaps even a recession, and higher unemployment.

So far, consumers aren’t playing along just yet, and the effect of the Fed’s work has been fairly muted.

The culprit Stateside early in the week was better-than-anticipated ISM services data for November (see here), which was above consensus at 56.5, and also well above the 50 threshold that ordinarily signals a retraction in demand. Recall that manufacturing PMI for the US in November, released the prior week, was below 50 (49, see here) for the first time in 29 months, suggesting the US manufacturing economy was finally slowing. This mixed scenario reflects perfectly what many of us are experiencing in both the US and Europe – slowing demand for goods but ongoing strong demand for services in labour markets that simply cannot deliver enough workers, contributing to disruptions in services and ongoing wage inflation. US PPI for November, released on Friday, also came in hotter than expected at 0.3% MoM (7.4% YoY), reminding investors that the fight against inflation is far from over (BLS release for November here). That read rattled US equity and bond markets on Friday.

In the UK, retail (nominal) sales for November were up +4.2% YoY for November according to the BRC (here), a strong figure on a headline basis but – with a 9.6% CPI rate in the UK (October YoY) – a much less impressive result when considering inflation. Do the maths – retail sales volumes declined. Eurostat reported similar results for the Eurozone for November, as retail volume sales declined 1.8% MoM (2.7% YoY, see Eurostat release here) in the common currency zone. In both economies, slower economic activity will put pressure on the Bank of England and ECB, respectively, to moderate future rate rises in spite of record-high inflation. It is not difficult to conclude that the UK and Europe are in a more precarious position than the US in this respect, essentially cornered, which of course raises the issue of why both Sterling and the Euro have strengthened so much over the last few weeks. This is a topic for another day, but let’s just say that the road ahead in the UK and Europe is going to be very difficult in the coming months.

One macro sign of what may lie ahead for the global economy can be gleaned from the price action of oil. Oil prices (WTI) fell a sharp 10.5% this week, and the price is now down 5.1% since the beginning of this year after peaking at $123.70/bbl (WTI) in early March. The march downwards in prices is signalling declining global demand for energy, another signal perhaps that global growth is slowing. (Keep in mind though that lower energy prices also are an indirect form of fiscal stimulus since consumers spend less on oil and gas and have more discretionary income for other items, at least in theory.)

My last diatribe this week concerns some chatter that the "recession is coming” trade is getting very crowded. Trades like this can and do get crowded, so it is certainly not a silly assertion. What are markets saying? As mentioned already, the bond market is emphatically screaming “recession”. The relative outperformance of more defensive equity indices / sectors vis-à-vis more momentum / growth equity sectors is probably screaming the same. Don’t forget that although the return on the DJIA is negative YtD, it is more than three times higher than the return on the NASDAQ. Trades do get overcrowded when everyone is going in the same direction, but I struggle to conclude that equities do not remain somewhat vulnerable given the combination of above-average valuations and a difficult earnings outlook (+4.5% to 5%,n nominal) for 2023. Perhaps during sell-offs, buying intermediate / long-term bonds and fairly-valued stocks makes sense, but aside from these plays, I remain fairly convinced that the US will see dramatically slower growth in 2023, whilst the UK and possibly the EU are already in a recession.

MARKETS THIS WEEK

Equities in the US and Europe all floundered about this week, whilst Asian and emerging markets equities continued to show relative strength as the US Dollar steadied. In the US equity market, the small-cap Russell 2000 was the worst performer, with the NASDAQ being the second worst performer. UST yields bounced around much of the week, but Treasuries sold off on Friday following the hot PPI read leading to higher yields at the short and intermediate end of the curve for the week. As mentioned earlier, the 2y-10y yield differential is hovering around its most negative level in over 40 years. Oil prices also fell again this week, providing net energy importers (like China) some relief. Corporate bonds were only modestly changed on the week, with investment grade credit spreads a couple of basis points tighter whilst high yield spreads were 10bps or so wider. The high yield market continues to show resiliency even as the probability of an economic slowdown in the US increases. It is hard to see this continuing indefinitely given ongoing monetary tightening.

Below is a summary of financial indices and assets for the week, with more detail provided in the section “The Tables”.

WHAT’S NEXT?

Below are some of the key data and economic releases and other events that matter for the weeks ahead.

• There is a significant amount of economic data coming out this week, including

  • UK: Manufacturing data (Oct), employment data (Nov), CPI (Nov, on Weds), retail sales (Nov) and preliminary manufacturing and services PMI data for Dec

  • US: CPI (all eyes will focus on this, released Tues before open), retail sales (Nov) and preliminary manufacturing and services PMI data for Dec

  • Eurozone: retail sales (Nov) and preliminary manufacturing and services PMI data for Dec

• Upcoming central bank meetings (expectations in brackets):

  • Federal Reserve – Dec 13th-14th (+50bps for Fed Funds / 5% terminal)

  • Bank of England – Dec 15th (+50bps in Bank Rate / 4.25% terminal)

  • ECB – Dec 15th (+50bps in key bank rates / 2.50% terminal / QT late 1Q23)

  • Bank of Japan – Dec 19th-20th (not even a discussion!)

THE TABLES

Global equities

US equities

US Treasuries

Corporate bonds (credit)

Safe haven and other assets

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