11th July 2023
Fourth of July puts short pause on Wall Street
Did you know? If put end to end, the total number of hot dogs consumed by Americans on the 4th of July would span the distance from Washington DC to Los Angeles more than five times.
Wall Street was closed for the Fourth of July holiday, so it was a quiet start to the week. But on Monday, global equities reached a two-week high, motivated by signs that slowing inflation might modulate central banks’ desire to raise interest rates further. Meanwhile, Japan’s Nikkei index reached a 33-year peak – but sadly, that optimism was short-lived.
Despite reports that the US manufacturing slump increased in June (reaching levels last seen when the country was still recovering from the first wave of the COVID-19 epidemic), Wall Street managed to nudge upward shortly before the holiday period. At that point, the contraction had continued for eight months in a row. In fact, manufacturing is being harmed not just by expensive borrowing costs but also by a shift from services to goods in regard to consumer spending.
China and eurozone show mixed signals
The middle of last week was marked by weak signals in China and the eurozone, which discouraged investors. While the Chinese services sector had bounced back strongly since the lifting of COVID-19 restrictions, it slowed down in the second quarter. In June, the activity expanded at its slowest pace in five months, and the expansion of business activity and new orders also decelerated notably. China is expected to present its second-quarter GDP data in mid-July.
Meanwhile, the eurozone was also facing a slowdown as its leading service sector contracted broadly. Business activity in the region dwindled while the manufacturing industry also shrunk more rapidly than previously estimated.
But it wasn’t all bad news. On Wednesday, data was released that showed eurozone producer prices had dropped for the fifth month in a row in May. Low producer prices typically appear before low consumer prices, so this was a welcome sign for the European Central Bank (ECB) – despite increasing borrowing costs to their highest level in 22 years last month, the ECB has been struggling to achieve its 2% inflation target.
Wall Street reacts to job market surprises
On Thursday, markets were faced with a reality check as data from US payroll processing firm ADP revealed that in June, 497,000 private sector jobs were added – more than double the consensus estimate. This news surprised Wall Street, causing a significant one-day drop in stocks, marking the largest fall since May. The robustness of the US labour market is expected to reduce the possibility of a recession in the country. However, this strength in the market also indicates that the Federal Reserve (Fed) may implement more aggressive interest rate hikes. The Fed aims to address what it perceives as “unacceptably high inflation” and eliminate any expectations of a rate cut in 2023.
The FTSE 100 closed at its lowest level in eight months, while markets reacted as the two-year US Treasury yield reached a 16-year high in response to the surprising job growth.
However, the official nonfarm US payrolls report released on Friday painted a somewhat gentler picture. In June, a total of 209,000 jobs were added, falling below the expected 230,000. Nonetheless, the job market remains healthy and supportive of overall consumption, although there are early indications of a cooling job market. This generally positive report is likely to strengthen the resolve of most Fed officials who believe that further interest rate hikes are necessary. They believe the economy can absorb them without causing a significant impact on employment, and as a result, traders are currently estimating a 92% chance of a rate hike at the Fed’s upcoming meeting.
Pimco, the world’s largest active bond fund manager, warned that markets may be too optimistic about central banks’ ability to avoid a recession. The company’s Chief Investment Officer, Daniel Ivascyn, highlighted that in the past there has been a delay of five or six quarters before the impact of rising interest rates is truly felt. He claimed:
“The more tightening that people feel motivated to do, the more uncertainty around these lags and the greater risk to more extreme economic outlooks.”
Central bank rate hike expectations and concerns
Investors were wagering that persistent inflation will drive the Bank of England to hike interest rates to a 25-year high of 6.5% by December in the UK during tumultuous trading on Thursday, driving the yield on 10-year gilts to its highest level since 2008. The governor of the Bank of England, Andrew Bailey, reaffirmed that the goal of the central bank was to bring inflation “all the way down” to its 2% objective.
Because of worries that savings interest rates are too low, the regulator called the heads of the UK’s banks into a meeting. Since there is now about twice as much of a difference between the average two-year fixed mortgage rate and the average quick-access savings account as there was in December 2021, some have suggested that lenders may be reaping excess profits.
Halifax stated that property prices had dropped 2.6% annually, the sharpest decline in 12 years at the time of the meeting. The narrowing of affordability as a result of rising mortgage rates will put a pause on demand. Additionally, it’s only a matter of time for mortgage holders whose fixed-rate agreements expire in the upcoming 18 to 24 months. From 16% in 2012 to 63% in 2017, more UK mortgages now have fixed rates for two years or longer.