Market Insight: Week Ending 25 August

Yields for government bonds in Europe also experienced a notable uptick, with the UK’s 10-year gilt yields reaching their highest point since 2008 and Germany’s equivalent yields rising to levels not seen since 2011. In the FX space, the US dollar attracted a safe haven bid consequently weighing on major currency peers), and precious metals pursued lower ground, along with a broad-based sell-off in the crypto space.

The FOMC minutes was one of the highlights last week and certainly stirred the pot regarding the market’s perception of the direction of the Fed Funds rate. The minutes surprised markets by striking a hawkish tone. The minutes noted that ‘with inflation still well above the Committee’s longer-run goal and the labour market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy’. Despite this, the market appears to overlook the possibility of another rate hike, with markets only pricing a 14% chance of a 25bps increase at the September meeting.

China’s economy was also a major talking point last week, weighing on market sentiment. Instead of the Chinese economy coming out of the gates raring to go following three years of zero-covid policy, we have seen the opposite. A series of economic data points have come in lower than expected in July. China’s economy also fell into deflationary territory at the beginning of the month as consumer prices declined for the first time since early 2021, with both the year-on-year CPI and PPI measures now deflationary. Retail sales also rose by only 2.5% in the twelve months to July (vs expected 4.5% [down from 3.1%]). Additionally, industrial production rose less than expected at 3.7% in the twelve months to July (vs expected 4.3% [down from 4.4%]), and China’s jobless rate ticked higher to 5.3%, up from 5.2%.

Wage and inflation numbers were the highlight for the UK last week. Unemployment jumped to 4.2% in June (vs 4.0% expected [up from 4.0% previous]). Additionally, private sector wage growth rose more than expected in the three months to June and surpassed inflation for the first time since October 2021 (underpinned largely by one-off payments to NHS staff in June). A day later, we saw consumer prices had eased to 6.8% in the twelve months to July (down from 7.9% in June and in line with market forecasts), driven lower by declining gas and electricity prices.

Core inflation for the same period was slightly higher than expected at 6.9%, versus the 6.8% expected, while YoY services inflation picked up to 7.4%, from 7.2%, which will be of particular interest to the Bank of England (BoE). Friday also observed retail sales for July fall -1.2% for the first time in three months (up from a 0.6% rise in June). The market is now pricing around 75bps of tightening, marking an increase of approximately 30bps from previous levels. The terminal rate is forecast at around 6.0%, and markets are almost fully pricing in another 25bp hike (85% probability) at the next MPC meeting on 21 September (this would mark its 15^th consecutive rate hike).

This Week…

The main focus for the US space this week will be on US Fed Chairman Jerome Powell’s speech at the Kansas City Fed’s Jackson Hole Economic Policy Symposium on Friday morning at 10:08 am ET. Markets will be watching the chief’s speech for clues about the direction of interest rates. Markets are almost fully pricing in a pause at the next Fed meeting on 20 September, with rates projected to remain in restrictive territory well into 2024. Other US macroeconomic points to be aware of this week are US manufacturing PMIs on Wednesday, durable goods orders data, and the weekly unemployment claims number on Thursday. Additionally, new and existing home sales for July will be available this week, as well as consumer sentiment data.

In the UK, eyes will be on the manufacturing and services PMI data, both of which are expected to come in lower than the previous month. It is much the same as the UK for the euro area this week. Focus is on the manufacturing and services PMI data, with the former expected to remain pretty much unchanged at 42.7 and the latter anticipated to drop to around 50.5.

G10 FX (5-Day Change):