Fed Vigilance Cools Markets
Equity markets ended the week in negative territory, snapping a four-week winning streak. In the US, the large-cap S&P 500 Index and the technology-laden Nasdaq Composite Index recorded losses on the week of -3.70% and -5.69% respectively, whilst the Euro Stoxx 50, a composite index of leading blue-chip companies across the Eurozone, dropped -3.47%.
A sharp rally in global shares from mid-June lows, stoked by investor expectations that central banks, led by the US Federal Reserve (the ‘Fed’), would pivot from their current stance and slow the pace of interest rates hikes, is showing signs of fizzling out.
Several Fed officials, led by St. Louis Fed President James Bullard in an interview with the Wall Street Journal, questioned whether inflation had ‘peaked’ for this cycle, and reaffirmed an intent to raise interest rates aggressively as part of broader efforts to tame inflation.
Bullard also stated that he was likely to vote in favour of another 75-basis point (0.75%) increase in the federal fund’s target rate at the next meeting, a position echoed by colleague Loretta Mester, President of the Cleveland Fed. This would represent the third successive increase of 75 bps; a scenario markets had recently begun to question as unlikely.
Positive surprises in the week’s US economic data are also, from the market’s perspective, a double-edged sword. Despite offering hopes of avoiding a deep economic recession, more resilient retail sales figures and a strong industrial production number (+0.6% month-on-month, almost double consensus expectations) are reinforcing rate hike fears.
This despite news that existing US home sales fell for the sixth consecutive month (-5.9%) as the rise in mortgage rates continues to filter through to household balance sheets. Heavyweight retail behemoth Target also reported a large profit ‘miss’ as shoppers continued to pull back on discretionary purchases. A mixed picture indeed.
Inflation numbers from around the globe came in a lot hotter than expected and will likely provide the ammunition that central banks need to maintain course. Eurozone inflation hit a record +8.9% in July, the highest since the EU currency was created in 1999, whilst factory-gate prices in Germany rose an astonishing +37.2% year-on-year, some 5% above analyst expectations. Time to rip up those forecasting models…
Closer to home, the UK’s inflation rate hit +10.1% in July, the first double-digit reading since February 1982. For a dose of nostalgia, the number one UK song at the time was ‘A Town Called Malice’ by the Jam. The core inflation rate, which excludes food and energy, also came in higher than expected, at +6.2%.
China’s economy continues to look increasingly fragile. President Xi’s zero-tolerance approach to COVID is becoming increasingly difficult to implement given the highly contagious Omicron variant. It was the worst seven-day period for China in terms of COVID infections since mid-May, with more than 18,000 new local cases recorded, according to Bloomberg.
Alongside renewed lockdowns, severe drought conditions are enveloping large parts of the country, destroying crops and triggering industrial action from disgruntled workers. The pressure is surely building at a politically sensitive time for Xi ahead of the 20th Party Congress, where he is expected to be given a renewed mandate, or the role of ‘leader for life’, according to observers.
Moving across to the world of crypto currencies, many are keeping a careful eye on Bitcoin as a barometer for broad risk appetite in this cycle. Amidst a more jittery market environment, Bitcoin and Ethereum fell -12.25% and -17.08% on the week. The rationale appears to be the Fed’s commitment to a) raising interest rates further, and b) draining liquidity from the system via quantitative tightening, or ‘QT’.
QT is a term we are likely to hear repeatedly over the coming months. It represents action by the US Central Bank to actively shrink the amount of assets it owns by selling them to the market. The objective is to reduce the amount of liquidity, or money supply, in the economy. This will increase the cost of accessing money, offering a very different environment to the easy financial conditions enjoyed by investors and asset owners over the past decade or more.
Finally, all eyes will be on the Rocky Mountain town of Jackson Hole, Wyoming, where the Fed will hold its annual three-day economic policy symposium beginning Thursday, 25 August. Chairman Powell is among the featured speakers, and market watchers will become body language experts, dissecting his rhetoric and tone for any perceived shift in outlook.
(Cover Image Source: Nicholas Cappello)