Despite the United States (US) Federal Reserve (Fed) having been adamant that higher interest rates can be expected for longer, many argued, following the softer US inflation print last week, that the Fed might move to pause interest rate hikes sooner than initially anticipated. This opinion led to a sell-off in the dollar, allowing for a risk rally that helped many commodity-linked and other risk-based assets to gain some momentum. This sentiment was, however, stopped in its tracks, as numerous Fed officials warned that the market’s optimism is unwarranted, and that the Fed will continue on its rate hiking path well into 2023. The latest comments came from St. Louis Fed President, James Bullard, who stated that “the policy rate is not yet in a zone that may be considered sufficiently restrictive”. By making use of the Taylor-rule (a formula linking central-bank policy rates to inflation and economic growth), Bullard indicated that the Fed funds rate could be as high as 5% – 7%, a much higher figure than current market pricing expectations and unofficial Fed forecasts.
Adding to market concerns, during the UK’s Autumn statement, Chancellor of the Exchequer, Jeremy Hunt, acknowledged that the UK economy is already in recession, with rising energy prices accounting for most of the revision in growth forecasts. Hunt continued by stating that the UK’s GDP will contract by an expected 1.4% next year, and then grow by 1.3% in 2024 and 2.6% in 2025. This vastly contrasts with the Office for Budget Responsibility’s (OBR) March forecast of 1.8% growth for 2023. Among other measures, which were broadly in line with market expectations, Hunt also announced the government would cut the threshold for the UK’s top income tax bracket of 45%, to £125,140 and freeze allowances and thresholds for income tax, national insurance, and inheritance tax for a further two years.
On the periphery, markets are also keeping a close eye on the number of COVID-19 cases in China, and what that could mean for the full re-opening and, subsequently, commodity demand of the world’s second largest economy. Meanwhile, tension between North and South Korea remains elevated, with South Korea’s military noting that North Korea fired a ballistic missile towards the Eastern waters, but gave no further details. This comes just hours after North Korea threatened to intensify military responses in light of the increased security commitment from the US to South Korea and Japan.
DATA IN A NUTSHELL
US annual producer price inflation (PPI) eased for a fourth consecutive month to 8% in October, coming in below market expectations of 8.3% and down from 8.4% in September. This was the lowest PPI print since July 2021. US retail sales gained 8.3% year-on-year in October, following an upwardly revised 8.6% increase in September, indicating strong consumer spending, despite high inflation and borrowing costs. Meanwhile, the number of Americans filing new claims for unemployment benefits fell by 4,000 to 222,000 for the week ending 12 November, below expectations of 225,000, pointing to a tight job market and giving the Fed leeway to tighten policy, despite the surge in layoffs from large tech companies.
China’s industrial production expanded 5% year-on-year in October, undershooting market estimates of a 5.2% increase, following a climb of 6.3% in the previous month which was the fastest rate of expansion in seven months. The slowdown highlighted that a recovery in the Chinese economy is losing momentum, amid rising COVID-19 cases and strict curbs, as well as a downturn in the property sector. China’s retail sales also unexpectedly declined by 0.5% year-on-year in October, shifting from a 2.5% gain in September and pointing to the first drop in five months.
The unemployment rate in the UK edged higher to 3.6% in the three months to September, up from 3.5% in the previous period. Vacancies fell for a fourth consecutive quarter to 1,225,000 but are holding at historically high levels. An increasing number of businesses are now reporting halting recruitment because of economic pressures. The annual inflation rate in the UK jumped to 11.1% in October from 10.1% in September, a significantly higher reading than the 10.7% that markets were forecasting. It is the highest inflation print since October 1981, with the main upward pressure coming from housing and household services like gas and electricity.
FED OFFICIALS SPOOK STOCKS
The US’s Dow Jones lost 200 points on Thursday, while the S&P 500 and Nasdaq lost 1% each as Fed officials continue to signal that the aggressive rate hikes are not over. Equities that are most vulnerable to a recession and higher rates, such as tech stocks, led the sell-off. On the other hand, Bath & Body Works skyrocketed over 20% after the retailer beat Wall Street forecasts. Tech conglomerate, Cisco, also added almost 4% after topping earnings and revenue estimates.
European shares also traded largely in the red on Thursday, as investors digested the UK’s Autumn Budget and a batch of corporate news. The pan-European STOXX 600 lost 0.5% and Germany’s DAX 40 dropped about 0.1%. Some positives on the corporate front saw manufacturing giant Siemens beat profit expectations and forecast strong demand for hardware and software, while steel and engineering conglomerate Thyssenkrupp proposed its first dividend in four years. Luxury goods brand Burberry’s quarterly sales growth also beat forecasts.
London-based equities also extended losses on Thursday, with the blue-chip FTSE 100 touching fresh daily lows at around 7,300, dragged down largely by utilities and materials stocks, as investors digested the government’s fiscal plan. On the corporate front, online grocery retailer Ocado Group and financial services firm Hargreaves Lansdown were among the biggest laggards on the FTSE 100, down 7% and 4%, respectively.
Japan’s Nikkei 225 Index fell 0.35%, while the broader TOPIX Index gained 0.15%, during mixed trade on Thursday, as stronger-than-expected US retail sales data and hawkish remarks from Fed officials stoked fears that the US central bank may tighten policy well into next year. Investors also reacted to data showing Japan’s trade deficit widened more than expected in October, as soaring import costs outpaced export growth. Technology stocks mostly declined, with Tokyo Electron shedding 3%, Lasertec trading down by 8.4% and Advantest falling by 3.1%.
DEMAND CONCERNS EXTEND FALL IN OIL PRICE
Brent Crude futures fell below $92/barrel on Thursday, extending losses from the previous session, as a weakening demand outlook took center stage, yet again. Investors fussed over a gloomy global economic outlook, with JPMorgan projecting that the US will enter a mild recession next year, due to the Fed’s rapid interest rate hikes. China also continued to grapple with rising COVID-19 cases that clouded the demand outlook in the world’s biggest crude importer. On the supply side, flows through the Druzhba Pipeline, which carries Russian oil to Hungary, have resumed following a brief power disruption. Traders remain watchful over the supply outlook as the European Union is set to ban Russian crude flows from December, while the Organization of the Oil Exporting Countries is expected to keep supply tight.
Gold prices sank below $1,770/ounce on Thursday, sliding for the second straight session as the dollar gained momentum, supported by stronger-than-expected US retail sales data that clouded the outlook for inflation and indicated the need for further interest rate hikes.
Newcastle Coal futures dipped below the $350/ton mark, a level not seen since early May of this year, and down more than 20% from their September peak, amid signs that supplies will be adequate to meet winter demand in Asia and Europe. The European ban on coal imports from Russia, as part of sanctions for its invasion of Ukraine, gave other producers, particularly South Africa, an incentive to boost production and exports. In addition, top consumer, China, vowed to raise coal production capacity by 300 million tons this year, which is equivalent to its annual coal imports.
Copper futures fell below $3.8/pound from the five-month high of $4/pound reached on 11 November, weighed down by concerns of lower demand. Data from top consumer, China, showed that industrial production slowed more than expected in October, while house prices declined for the sixth consecutive month, and further emphasised low demand for the country’s highly indebted property developers. Copper prices however remain 11% higher since the start of November as looming supply concerns limited its price decline.
HAWKISH FED CAMPAIGN STRENGTHENS US DOLLAR AGAIN
The US Dollar Index strengthened towards the 107 mark on Thursday, as investors’ expectations for a pause in interest-rate hikes started to fade following numerous hawkish statements by Fed officials throughout the week. Markets are, however, still pricing in a 50-basis point rate hike in December, and a series of 25-basis point increases next year. The most pronounced buying activity was against risk-sensitive currencies such as the Australian and New Zealand dollars. The greenback also gained sharply against the British pound after the UK unveiled tax increases and spending cuts to help tackle inflation.
The euro weakened to $1.03, and remains marginally above parity, after touching a more than four-month high of $1.04 earlier this month, as the dollar’s rally gained steam, yet again. Meanwhile, the European Central Bank (ECB) may slow down the pace of rate increases next month, with the odds for a 50-basis point rate hike, instead of another 75-basis points, rising. The ECB needs to balance record-breaking inflation levels against an increased risk of recession. While the eurozone economy avoided a contraction in the third quarter, GDP is set to shrink in the last quarter of 2022 and in the first quarter of 2023, only returning to growth in the spring of next year, according to the European Commission.
The British pound also extended losses, shedding 1% to trade at $1.180 on Thursday, down from a near three-month high of $1.20 seen on 15 November, on the back of the UK’s economic growth woes. Following remarks by Chancellor Hunt, UK money market futures pointed to the Bank of England raising interest rates to a peak of 4.53% by August next year, which is below the 4.59% expected before the Autumn Report.
The pound started the day trading at 1.1862/$ and 1.1440/€.
Written by Citadel Global Director, Bianca Botes
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