What’s going on in financial markets? Which macro themes should you watch? Drawing on our depth and breadth of market and economic expertise, Market Pulse brings you insights on the latest investment themes to help preserve and grow your wealth.
Market views
- Some turmoil in financial markets last week as bond yields spiked higher, although they had been grinding higher for some time. The focus was on the minutes of the last FOMC (interest rate setting committee of the Federal Reserve) meeting which were interpreted as hawkish. There was no change in the path of interest rates but what did catch people’s attention was the comment that the US economy remains much stronger than expected and certainly more resilient to policy tightening than had been expected. It confirms that the Federal Reserve wants to see a slower economy and will keep policy tight until that happens. The risk of a hard landing rises.
- After the turmoil sparked by events in the US and European financial sectors, fixed income markets had started to show signs of easing volatility. Government bond yields which fell dramatically in March have gradually retraced higher whilst credit spreads have reversed from the March highs.
- Although inflation numbers remain elevated, some signs of a peak have started to emerge. This has been reflected in longer duration assets remaining somewhat range bound, whilst short duration yields have risen in line with continued central bank hikes. As a result, the inverted nature of fixed income curves, whereby front-end rates are significantly higher than long term rates, has become even more extreme. In the US, the two-year interest rate is currently 4.90%, which is 0.90% higher than the US 10 year rate at 4%.
- Against this backdrop, the strategic preference remains unchanged. Short duration assets offer more attractive yields relative to longer duration assets, whilst limiting risk sensitivities to interest rate moves. In addition to this the resilient economic backdrop and strong financial health of corporate balance sheets supports an overweight allocation to investment grade corporates.
Macro views
- The Employment report was the major data release in the US last week and provided some relief. The increase in non-farm Payrolls was lower than expected and there were downward revisions to previous month figures. The labour market is healthy with 209,000 jobs added during the month, but it is cooling which will give some comfort to the Federal Reserve.
- The other main releases were the ISM surveys (business sentiment). The message here was a resilient economy with a struggling manufacturing sector. The non-manufacturing index climbed jumped over 3 points to 53.9 in June. Better than the forecast level of 51 and well into expansion territory. On the other hand, the manufacturing report disappointed falling further into contraction territory. One bright spot was a pick-up in the New Orders sub-index which could indicate a bottoming in the main index soon.
- Data is still underwhelming in the euro area. Retail sales were flat in May against forecasts for a 0.2% rise. This has been impacted by the switch to services consumption, but one would have expected this to wash through at this stage.
- There was more weak data from China. Last week it was the Caxin Services PMI (business survey) which is more weighted to privately owned businesses in China. It was expected to drop one point to 56.2 and instead fell over 3 points to 53.9. The reopening boost is fading faster than people expected but this could induce more stimulus from the government.
Chart of the week: What a difference a month can make
One of the reasons for our cautious positioning is the outlook for the US economy and its impact on the global economy and with it profits. We fear the impact of the monetary tightening that has occurred in the US. The chart above shows the percentage of banks in the US that are tightening their lending standards and as you can see outside of the great financial crisis and the pandemic shutdown it has never been higher. This will impact on new lending but also any loans that need to be rolled over. This leads to the long and uncertain lags of monetary policy and remains a threat to the performance of the US economy.
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