United Kingdom

Market sell-off gains momentum as UK worries intensify

The UK economic outlook is creating a deepening sense of alarm amongst the financial markets. Not only is the GBP under pressure, but the sell-off in UK gilts is rapidly turning into a rout. The surge in UK yields since the beginning of August has been eye-watering, with 5-year gilt yields rising from 1.62% to over 2.85%, and 10-year gilt yields rising from 1.88% to 2.92%. Despite the surge in UK yields, which has prompted forward points for GBPUSD to turn negative from 15 months out, the pound has benefitted from no recovery, as economic and political worries have increased. The economic concerns come after the energy price cap increase, warnings from the pub industry of mass closures and credit card borrowing rising at its fastest pace in 17 years. The political concerns come after Liz Truss, the winner of the race to succeed Boris Johnson as Conservative Party leader and Prime Minister, took a firm line on the Northern Ireland Protocol in the last week of campaigning. Her victory was announced just after midday on Monday, and now the job of forming a cabinet and outlining her plans for the economy take centre stage.

It appears to me increasingly obvious that the monetary policy actions of the Bank of England, which have been stepped up recently, are neither having an effect on inflation as yet, nor have they supported the GBP either. The risks for the UK are that if the Bank of England continues to raise interest rates, this will only worsen the economic outlook further, and that will undermine the GBP more than the rise in interest rates would prove GBP supportive.

For this week, there isn’t much data or survey evidence due for release. The final-August services PMI (Purchasing Managers’ Index) reading, British Retail Consortium sales monitor and the RICS (Royal Institution of Chartered Surveyors) house price balance outturn for August will only likely point to an additional slowing of momentum. Under these circumstances, the downside risks to the GBP remain, against both the USD and EUR, in my opinion. It is becoming increasingly difficult to see what would prove supportive of a GBP rally, at least from the UK economic releases. However, currency market participants have already sold the GBP fairly aggressively. That just might slow the momentum of the sell-off down for a short while, in my view.

Europe

European Central Bank considers bigger hikes as the inflation problem grows

Last week saw the August estimate for Euroland consumer price inflation exceed 9%. This was more than the markets had anticipated and was also likely higher than the ECB (European Central Bank) expected CPI (Consumer Price Index) inflation to print. Subsequently there was a sharp increase in rate hike expectations, and commentary from some quarters of the ECB Governing Council indicated that a 75 basis point hike was now actively being considered. The financial markets price for just such a move from the ECB at this Thursday’s meeting, and that in spite of more economic news that suggested the economy is getting worse, that worsening could accelerate in the weeks to come. 

Already this week, the final August services PMI reading from Euroland dipped below 50, and was worse than the initial reading. The Sentix investor confidence reading for September also slipped by more than expected, and the data and surveys over the course of the remainder of this week are likely to point to more problems. German factory orders and industrial production figures for July are expected to report a further sharp drop, and there could be weakness elsewhere across Euroland in terms of industrial production/output figures.

If the European Central Bank does hike 75 basis points, its President Christine Lagarde might indicate that this is the ECB front-loading its hikes. There may also be reference made to the weakness of the euro, although I’m not sure what the ECB could say or do to arrest the euro’s decline against the US dollar, given heightening geopolitical risks and increasing odds of recession. The financial markets appear to be very much in risk-off mood, something that so far no central bank appears too concerned about. Is that complacent though?

United States

Payrolls beat market expectations; Beige Book in focus this week

The US payrolls data offered relatively little new impetus to financial markets last week. The slightly better than expected outturn from the headline net payrolls gain for August was tempered by a downward revision to the previous two months of payrolls gains of more than 100,000. Moreover, the unemployment rate increased unexpectedly to 3.7% from 3.5%, underemployment rose to 7% from 6.7%, and average earnings growth undershot market consensus forecasts again. The labour market is behaving somewhat oddly, perhaps still benefitting from a post-COVID bounce, and yet to absorb the downgrade to the economic growth outlook. Last week also saw more evidence from the housing market that it was far from well, with house price growth stagnating unexpectedly and mortgage applications falling to a fresh multi-decade low.

The US dollar continued to benefit from safe-haven flows, despite the notable underperformance of US yields against other major economies. It would appear to me that there is less panic regarding inflation in the US versus the UK and Euroland, given that the US is far less exposed to the effects of Russia’s constant readjustment of gas supplies. The USD index hit fresh highs last week, and followed that up with a break over 110 on Monday morning. The high of 110.27 was last seen in June 2002, when the world looked a very different place to now!

For this week, the main focus is on the speakers from the Federal Reserve and its latest assessment of current US macroeconomic conditions (Beige Book). I doubt this will change much as far as market sentiment is concerned, but will we see some additional evidence of economic problems manifesting themselves across sections of the US economy? I suspect the Federal Reserve recognise that the economic risks are growing, and as such may tread somewhat more cautiously in its language around the macro economy in the Beige Book. That just might stall the USD’s progress temporarily.

Central banks

A host of hikes from global central banks this week

Last week saw the Hungarian central bank raise interest rates to 11.75% the highest level they had been since April 2004. This was in line with market expectations and the central bank warned of more hikes to come, despite the collapse in Hungarian home sales, and ever-increasing signs of financial distress in the household and corporate sectors. The focus on trying to get inflation back under control has been hijacked by the ongoing restrictions on gas supplies from Russia that has raised wholesale gas prices to new record levels recently, but the Hungarian government signed a deal with Gazprom for 5.8 billion cubic metres of natural gas last week also.

For this week, there are a plethora of central banks readying themselves for hikes. The Reserve Bank of Australia is expected to hike interest rates to 2.35% from 1.85%, although might ease the hike to only 25 basis points if the recent dip in the housing market and drop in energy prices is viewed as more than temporary. The central bank of Chile is also expected to hike given the recent inflation outturns, but recent Chilean peso strength might be the reason the hike is limited to 50 basis points. Next we have the National Bank of Poland (NBP). In contrast to recent big hikes of up to 1 percentage point, this time around the NBP may only hike 25 basis points given the contrast between overshooting inflation and underperforming economic output. The Bank of Canada is expected to hike by 75 basis points, but the stronger than expected consumer price inflation is a risk for a larger hike, in line with the July increase. The National Bank of Malaysia is expected to hike by at least 25 basis points, with the risk of a 50 basis point hike, but the strength of the economy might be an illusion thanks to the momentum from reopening of non-essential businesses. The BNM (National Bank of Malaysia) should stick to as limited a hike as possible, given that global activity is weakening, in my view. Finally, the central bank of Peru is expected to close out the week with a 50 basis point hike, after some robust economic data since the last meeting.