Market Watch: Sept. 30, 2022

The U.S. Federal Reserve’s (the Fed) preferred metric to measure inflation rose more than expected in August, according to data released by the Bureau of Economic Analysis (BEA). The personal consumption expenditures (PCE) price gauge climbed by 6.2% year-over-year (YoY) in August from an upwardly revised 6.4% reading, higher than consensus estimates of 6.0%. On a monthly basis, prices rose 0.3%, also higher than last month’s reading of -0.1% and forecasts of 0.1%. Core PCE, which excludes the volatile food and energy components in the calculation, was up 4.9% YoY from 4.7% previously and 0.6% month-over-month (MoM) from 0.1%, indicating that inflation pressures are broadening. Goods had decelerated by 0.3 percentage points compared to the prior month due to deflation in non-durable items, but it was the services sector (+0.6%) that cast upward pressure on costs. Housing and utilities (+0.8%), transportation (+1.9%), and food services/accommodation (0.6%) all rose compared to July. Other data released by the BEA showed that nominal personal income was up 0.3% MoM, with wage growth cooling to 0.3%, the smallest advance this year. This is likely a welcome sign for the Fed as it seeks to tamp down on wages, one of the causes of higher inflation. Nominal personal spending was also up 0.4% from a downwardly revised -0.2%, while real consumption ticked higher by 0.1% from -0.1% previously. Consumption was supported by a reprieve in gasoline prices which helped to spur spending on services while goods spending weakened. That said, it remains to be seen how long consumers can sustain current consumption levels amid the combination of rising interest rates and high inflation. Data from the Fed showed that consumer debt amongst the bottom 90% of earners has soared by US$300 billion over the past year, the largest annual gain on record. Total liabilities for this segment of households are sitting at US$4.2 trillion, the highest ever. Fed Chair Jerome Powell has said that households may need to endure some pain in order to tame inflation headwinds. Meanwhile, Cleveland Fed President Loretta Mester recently opined that a recession will not prevent further rate hikes, bolstering the case for aggressive monetary tightening in the months ahead. Markets are pricing in another 100-125bps of rate hikes by the end of this year.

China

The official Chinese PMI slightly increased to 50.1 in September, highlighting the weakening global demand for Chinese goods. The data showed that while manufacturing improved marginally, the service sector declined, reflecting that the Covid Zero policy continues to weigh on consumption. The impact of Covid has been seen in sectors such as retail, catering, and travel-related services. The non-manufacturing gauge, which measures activity in the construction and services sectors, declined to 50.6. The Caixin manufacturing PMI, which focuses on small private companies, also fell to 48.1, underscoring weaker conditions for small businesses and exporters. Further, the demand from overseas for Chinese goods is also moderating. The data showed that new orders continued to signal contraction, while export orders declined further, suggesting external demand weakened at a faster pace. On the bright side, government infrastructure spending is boosting growth, which led to the construction index climbing above 60 in September. Meanwhile, China’s central bank (PBOC) is worried about the yuan, which has lost more than 11% to the dollar so far this year. The PBOC has asked major state-owned banks to be ready to sell dollars in exchange for the local currency to defend the yuan. However, no official announcement has been made yet.

Japan

Retail sales in Japan increased 1.4% MoM in August, despite the decrease in consumer confidence, while factory output expanded by 2.7%. Japan’s economy is showing signs of recovery, suggesting little need for an oversized spending package from Prime Minister Fumio Kishida to support growth. Factory output and retail sales are back at pre-pandemic levels and at their strongest since September 2019. While the expectation is for the economic recovery to slow this quarter, the data shows the economy may not need a huge infusion of government spending at this point. However, Kishida said the measures will mitigate the impact of accelerating price gains and the sliding yen. Before the data came out, economists were forecasting Japan’s economic growth to slow down in the current quarter, however they project now annualized gains of 1.6% in the quarter ending this month. Meantime, the demand appears to be weakening in Japan’s trading partners. Europe and the U.S. continue to raise interest rates to fight inflation, while China’s economy is slowing down due to its ongoing Covid Zero policy. Another problematic factor for Japan is the yen’s historic slide, amplifying import costs for food, energy and production materials, an outcome that could damage consumption and growth. On the other hand, the weaker currency could boost tourism as Japan’s border controls get fully lifted in two weeks and also helped Japanese companies to book more profits by boosting their overseas earnings.

Spotlight

Eurozone inflation hits new record while U.K. Prime Minister Liz Truss doubles down on her economic plan

First ever double-digit inflation reading for the eurozone ups pressure on the ECB for aggressive rate hikes – Year-over-year (YoY) inflation in the euro area jumped to 10.0% in September, higher than consensus forecasts of 9.7% and last month’s reading of 9.1%, according to preliminary estimates released by Eurostat. This marks the first-ever double-digit CPI reading for the region and the fifth consecutive month that inflation has outpaced consensus estimates. As has been the case in prior months, energy was the primary contributor to higher prices, rising 40.8% from a year ago, followed by food/alcohol/tobacco which was up 11.8%. Excluding the volatile food and energy categories, prices were up 4.8% YoY from 4.3% previously, pointing to broad-based cost pressures. On a regional basis, German CPI rose to 10.9% YoY following the expiry of government subsidies on fuel and transportation, while France saw a surprising downturn to 6.2% from 6.6% previously. Meanwhile, a separate report showed that unemployment held at an all-time low of 6.6% in August. The combination of tight labour markets and persistent inflation ups the pressure on the European Central Bank (ECB) to raise policy rates at upcoming meetings. Indeed, recent comments from Governing Council members have been skewed to the hawkish side, with Martin Kazakhs of Latvia voicing his support for a second straight 75bps move higher. The economic outlook for the region has dimmed considerably in recent months with Russia starving Europe of gas supplies and the winter season fast approaching. In its latest report, the Organization for Economic Co-operation and Development (OECD) raised its 2023 inflation forecast for the region by 1.6 percentage points to 6.2%, exceeding the ECB’s own outlook. ECB President Christine Lagarde has said that there are considerable upside risks to the inflation trajectory, reflecting the possibility of further energy supply disruptions. That said, governments are in the process of ramping up fiscal stimulus to offset the effect of soaring energy costs, which may provide some cushion to households.

U.K. Prime Minister Liz Truss doubles down on her economic plan which has roiled the pound and gilts market over the last week – Liz Truss’s government signalled today that it remains committed to the tax cuts it announced this time last week after a meeting between the Office for Budget Responsibility (OBR), Chancellor of the Exchequer Kwasi Kwarteng, and the Prime Minister. Notably, the new administration declined an offer from the OBR to provide an independent forecast detailing the potential implications of the tax cuts. One Treasury Minister justified the lack of an independent forecast by saying that the government had additional plans to announce that needed to be factored in. A complete forecast from the OBR is due to be published on November 23 alongside Mr. Kwarteng’s medium-term fiscal statement. The market’s reaction to the unfunded tax cuts had dropped the pound to a record low and sent gilt yields higher. Subsequently, the Bank of England’s (BoE) hand was forced as they pledged to become a temporary buyer of gilts, reportedly due to strains in the country’s pension plans which were facing margin calls. Notably, investment management company Blackrock had warned that it may halt trading for funds using liability-driven investing strategies, affecting clients at the centre of the turmoil. The lack of confidence in the new administration’s policies has prompted a reaction from the likes of the International Monetary Fund and credit rating agency Moody’s, who have urged the Prime Minister to reconsider her plans. It has also allowed the labour party to capture a 33% lead in the polls, the largest lead for any party in two decades. Although the next general election is not due for another two years, the polls reflect the unpopularity of the government’s economic plan

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Market Watch: Sept. 30, 2022

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