We start the week where we left off Friday with a continuation of the risk-off moves we have been witnessing over the past 2 ½ weeks. Equities weaker and the US Dollar rallying further.
Big week for the markets last week as a number of central banks raised rates and warned that further tightening would be needed as major economies reel from multi decade highs in inflation.
At the start of this week, sterling has fallen sharply again but the picture is more complicated as the US Dollar is rallying versus all majors in the wake of the US rate hike last week and Russia’s part mobilisation of its armed forces.
Review of last week’s key action
FTSE -218 -3% DOW -1,232 -4% S&P -180 -4.65% NASDQ -580 -5.07% DAX -457 -3.6% NIKKEI -413 -1.5% Hang Seng -828 -4.4%
The Federal Reserve raised rates by 0.75% as expected which is the third such rise in a row. Jay Powell did not know whether the US economy would slide into recession as a result but reiterated the bank focus on bringing down inflation at all costs. Powell has effectively ruled out the idea US economy would avoid a recession insofar as the bank’s sole focus is to get a grip of inflation – at the expense of the economy if need be. So the likelihood of the US economy experiencing what’s called a soft landing seems quite remote.
The Fed’s rate setting committee now expect rates to hit 4.4% by year end and to peak at 4.6% in the second half of 2023. In consequence this further risk-off move last week resulted in falls in equities as investors priced in higher rates for longer which caused bond yields to firm up and equities to fall.
The NASDAQ was hit the worst, falling 5%, as many tech stocks that have enjoyed cheap funding are now finding investors are having to pay a lot more for future earnings.
Here in the UK, the Bank of England’s anticipated rate rise of 0.5% on Thursday turned out not to be the main event. The mini-budget announcements by the new UK Chancellor last Friday surprised a number of commentators as the Conservative Party shifted the focus of policy to economic growth at the expense of fiscal prudence in the medium term.
It was a challenging day for global markets anyway so UK markets, in common with other economies, were seeing a big fall in equities and rise in bond yields. However the tax cuts that were announced caused UK Gilts to fall sharply as yields rose in response to the massive amount of Bond issuance that would be needed to finance this tax giveaway.
In effect investors, many overseas, will need higher returns for such a sudden increase in supply of Gilts in what some commentators describe as a big gamble by this new administration. Comments over the weekend from Kwasi Kwarteng that he wants to keep cutting taxes may unnerve investors even more on Monday.
The downside impact has been roundly condemned as a big tax give away, seemingly to benefit the rich but much of what was announced was reversing previous rises in taxes by Rishi Sunak. The cut of the top rate tax to 40% may be controversial but it is designed to make the UK an attractive destination for businesses and business owners to locate to. The top rate of tax was hiked by Alistair Darling from 40% to 50% in the last throes of the last Labour Government and was seen as vindictive. George Osborn cut this rate to 45% and that is where it remained until the announcement on Friday.
The cut in the top rate of tax along with a cut in basic income tax rate by 1% comes in on April 6th 2023. The effects of these tax cuts may take a while to be felt. Analysts expect such fiscal events to take up to 18 months to take effect which will be close to the next general election – hence the rush that the government appears to be in.
EURUSD -3.25 -3.26% GBPUSD -5.66 -4.95% USDJPY +0.33 +0.23%.
The US dollar rally was another symptom of the risk-off move last week as the dollar rallied sharply against the Euro and even more so against Sterling. The risk for the UK economy is that the tax announcements could drive inflation even higher resulting in more pain for mortgage holders and companies’ finances.
Sterling slumped sharply on Friday as UK Gilts tumbled sharply in response to the Chancellor’s announcements. Further data crunching will be done over the following days but already it seems Labour will stick with the cuts in National Insurance and the 1p off income tax, but will reverse the cut in the top rate of tax. This provides a very clear dividing line between the Tory and Labour parties as the current administration focusses on growth.
The question is, when will the economic growth be felt because the inflationary pressure from such moves will be more apparent in the short term.
Gold -32 -1.91% UK OIL -4.85 -5.3% US OIL -5.97 -7% Bitcoin -883 -4.3%
No surprise to see US Dollar based commodities fall again with Oil reacting again to a possible recession in the US whilst China continues to inflict economic damage on itself through rolling lockdowns in the face of flare ups in covid.
Data / events for the week ahead
After the frenetic week last week for markets and that much
anticipated rate hike by the Federal Reserve, and the Bank of
England, we have less inflammatory data out this week.
This week is littered with Central Bankers speeches which always
Attract attention. No major Central bank policy announcement
though. The most important release being the flash CPI
estimates.
Monday:
Italy - Early Monday and Italy looks to have chosen a new Prime Minister and a far right coalition to govern the country. The Polls suggest the Giorgia Meloni who leads the far-right Brothers of Italy party will succeed. If so, the result could increase tensions between Brussels and Italy.
Germany - IFO Business Climate. Sliding further as the German economy is likely in a recession.
ECB - Lagarde due to testify before the Committee on Economic and Monetary Affairs, in Brussels; Eurozone equities and Euro sensitive.
Tuesday:
US Core durable goods. +0.3% - slowly declining over the past 5 months. USD and equities sensitive.
US - FOMC member Bullard speaking at International Monetary Policy Forum, in London about economic and monetary policy challenges. That could be interesting!
US - CB consumer Confidence – With inflation remaining more stubborn than the market was hoping, a pick in sentiment would be a surprise.
Wednesday:
US - Jay Powell - pre-recorded speech at Banking Research Conference.
Thursday:
US - More FOMC members speaking. Bullard and Meister. Any clues to further rate rise would be interesting especially from Q&A at Meister’s speech.
Friday:
Eurozone - CPI Flash estimates. Headline and core. Key data of the week as markets rest on every move from Central banks – which in turn are determined by the rises in inflation.
US - Revised reading of University of Michigan Consumer sentiment. A modest recovery since June but still fragile given the pace of interest rates rises. Equities more sensitive than the US Dollar.
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