weekly update 15 October

A sell-off in equity markets

Equity markets fell last week, as inflation concerns appeared to take hold with something of a delayed reaction from the previous week. Indeed, there was no data release to trigger the sell-off, whilst the CPI inflation report was actually softer than expected (see below).

Rather, equity investors seemed to dwell more on the upward bond yield movements from the previous week and the potential risks of tighter monetary policy, effectively hitting some of the complacency in the market, and prompting a tirade by US President Donald Trump against the US Federal Reserve (Fed).

The reality is that these moves simply take markets back to where they were earlier in the year, driven by short-term sentiment. In this environment, we believe it is important to focus on the core fundamental backdrop (which is unchanged in our view) and look through the market noise.

US inflation was soften than expected

US CPI inflation data was softer than expected, somewhat helping to mollify volatile markets. Headline CPI slipped from 2.7% to 2.3% year on year (yoy), versus market expectations for 2.4%. Core CPI, which strips out direct food and energy costs, remained unchanged at 2.2% (an increase to 2.3% was expected).

It was a 3% decline in used vehicle sales that helped to shave the extra 0.1 percentage points off the numbers. Apparel also detracted on an annual basis, with the 0.9% month-on-month (mom) bounce in September not enough to offset the -1.6% fall in August. Most other components registered steady gains, and a trend of gently rising inflationary pressures remains, though there is still no sign of this getting out of control.

It therefore seems likely that the Fed will stick to its gradual tightening path, and the recent moves in the US Treasury market suggest bond traders are moving more in line with the Fed’s projections. Current forecasts clearly signal one more hike this year, with two (market implied) or three (Fed implied) more in 2019.

European industrial production rebounded

Industrial Production rebounded across Europe, but still remains fairly subdued. In the UK, Industrial Production for August picked up from 1.0% to 1.3% yoy (against forecasts for no change), with the Manufacturing sub-component coming in at 1.3% (the July reading of 1.4% was revised up from 1.1%).

In the Eurozone the story was even better, as Industrial Production picked up from 0.3% (itself upwardly revised from -0.1%) to 0.9% yoy, well ahead of market expectations for a deterioration to -0.2%.

Whilst this rebound may have helped bolster sentiment, the barely-positive reading is a far cry from the peak annual production growth of just over 5% that we saw coming into the year, and reinforces a sense of slowing momentum.

Last week’s other events

• In China, the Caixin Composite PMI reading rose marginally from 52.0 to 52.1
• The University of Michigan reported its sentiment index for the US dipping from 100.1 to 99.0 (100.5 was expected). We also saw US Import Prices rise 3.5% yoy, down from an upwardly-revised 3.8% but ahead of the 3.1% expected. Export Prices rose 2.7%, down from 3.5% and below the 2.9% expected

The markets

Equity falls accelerated last week, with only a limited rally late into the US session on Friday. Core sovereign bond yields fell on the back of the risk-off flows, but the magnitudes were smaller than many may have expected – which is logical within the thesis that rising bond yields caused this rout in the first place.

One-month performance of major asset classes in sterling terms

Equities

Of the markets we report in this update, the Japanese TOPIX bore the brunt of the sell-off, finishing down 5.0% by the end of the week. Continental Europe and the UK were down -4.4% and -4.7% respectively at close on Friday (as measured by the MSCI Europe ex-UK and MSCI United Kingdom indices), whilst in the US the S&P 500 rebounded from a -5.4% close on Thursday to finish the week down ‘only’ -4.1%. Perhaps surprisingly, it was the Emerging Markets that fared the best, though the market was still down -2.3% for the week (in local currency terms).

Bonds

10-year UK gilt yields fell 9 basis points (bps) to finish the week at 1.63%, whilst the equivalent US Treasury yields slipped 7 bps to finish at 3.16%. 10-year German bund yields were 8 bps down to 0.50% and 10-year Japanese Government Bond yields were just half a basis point lower to 0.15%.

Commodities

Gold benefited from some of the sentiment flows, rising to US$1,217 per ounce on Friday, whilst Brent Crude fell to the low 80s, ending at US$80.43 per barrel. Copper was slightly stronger, up to US$2.80 per lb.

Currencies

The Japanese yen was broadly stronger, up over 1% versus sterling, whilst there was relatively little movement in the other major currencies last week. Sterling closed on Friday at US$1.32, €1.14 and ¥148.

The week ahead

There are a few points to watch for in the week ahead. There’s quite a lot from the UK, where we have wage data on Tuesday, CPI inflation on Wednesday and Retail Sales on Thursday. US Retail Sales on Monday afternoon will also be of interest, as will the Federal Open Market Committee (FOMC) minutes, released on Wednesday evening. On Friday China releases a batch of data, including third-quarter GDP numbers as well as Retail Sales, Industrial Production and Fixed Asset investments. See below for the details. On the politics front, the Italian Budget will be formally submitted to the European Commission, as well as continuing newsflow around Brexit. The daily breakdown is as follows:

Monday: US Retail Sales are the only notable release, with the market expecting a figure of 0.6% mom from 0.1% last month.

Tuesday: Ahead of the broader release on Friday, China reports CPI inflation, which is expected to have risen from 2.3% to 2.5% yoy. UK Average Weekly Earnings are forecast to have remained unchanged at 2.6% yoy whilst the unemployment rate is also expected to be unchanged at 4.0% (three-month average). The ZEW Business Sentiment Survey results for Eurozone businesses are published later in the morning, and then in the afternoon the US will report on Industrial Production (0.2% from 0.4% mom expected) as well as capacity utilisation.

Wednesday: UK CPI is expected to have cooled from 2.7% to 2.6% yoy, with core CPI also expected to have slipped by the same amount to 2.0%. The FOMC minutes in the evening will provide some more input around the latest thinking at the Fed, though the minutes could seem somewhat dated, given the meeting took place before the recent volatility.

Thursday: Japan releases trade data in the morning, before UK Retail Sales figures, where growth is forecast to have picked up relative to a year earlier, from 3.3% to 3.6% yoy (though on a month-on-month basis, markets are forecasting a slip from 0.3% to -0.4% for September). The afternoon will provide us with the latest US jobless claims data.

Friday: Japanese CPI is released just after midnight UK time, and is expected to remain unchanged at 1.3% yoy, with core inflation also expected as unchanged at 0.4%. A couple of hours later, but still early UK time, the Chinese data release will include third-quarter GDP (a slowdown from 6.7% to 6.6% yoy is expected), Retail Sales (no change at 9.0% yoy expected), Industrial Production (a slowdown from 6.1% to 6.0% expected) and Fixed Asset Investment (no change at 5.3% yoy expected for the year-to-date figure).