At the close of business last Friday, global equities eased on the week amid fears the US Federal Reserve could raise rates as much as a full percentage point at its upcoming rate-setting meeting. The yield on the US 10-year Treasury note declined to 2.91% from 3.09% a week ago as the yield curve flattened considerably following a sharp rise in US consumer prices. The price of a barrel of West Texas Intermediate crude oil fell $5 to $98 while volatility, as measured by the Cboe Volatility Index (VIX), fell to 24.69 from 28.4 a week ago.
From east to west and north to south, central banks tighten policy
The Bank of Canada surprised markets this past Wednesday by hiking its policy rate 100 basis points to 2.5%, the largest hike in 24 years, amid higher and more persistent inflation than the bank expected. The Philippines raised rates 0.75% while the Reserve Bank of New Zealand and the Bank of Korea each hiked by a half-point. The Monetary Authority of Singapore also tightened monetary policy by shifting its nominal effective exchange rate.
CANADIAN ECONOMIC NEWS
The housing market in Canada is experiencing a continued slowdown with a decline of close to 2 per cent year over year. The volume of home sales is also falling with the increase in interest rates. Our view is that our central bank had to take the aggressive action of increasing interest rates by one per cent to tame inflation, which has proven to be much more persistent than we thought at the beginning of the year. Our central bank will meet again in September and if inflation shows signs of moderating by that time, I believe we can expect more moderate future rate hikes with the prospect of interest rates coming down in the 2nd half of 2023. What this means to us is that our real estate markets will probably remain soft for 2022 and 2023 and then rebound in 2024 as interest rates normalise.
US ECONOMIC NEWS
With only about 6% of the constituents of the S&P 500 Index having reported for Q2 2022, blended earnings per share show that earnings growth is running at 4.7% while sales rose about 10.2% compared with the same quarter a year ago. The pace of earnings growth in Q1 was about 9.2%.
Fed officials downplay odds of a full-point hike
Larger-than-expected rises in US consumer (9.1%) and producer prices (11.3%) in June had investors nearly fully pricing in a 100-basis point rise in the fed funds rate at the 27 July meeting of the Federal Open Market Committee meeting before several committee members suggested that a 0.75% hike might be more appropriate. As of Friday, there is a roughly 40% chance of a full-point hike. The broad-based nature of the inflation surge, which has spread far beyond just food and energy, has investors questioning their assumption that inflation is close to a peak. The prospects for rapid rate hikes, and the increased risks of those actions resulting in a recession, undermined equity markets and dramatically flattened yield curves this week. The closely watched 2-year/10-year yield curve inverted more deeply after the data, to -21 bps on Friday morning after falling as far as -27 bps in the wake of the CPI report. Commodities weakened in anticipation of a global growth slowdown while the US dollar index reached a 20-year high at midweek as wider interest rate differentials and global risk aversion supported the greenback versus a basket of currencies.
Recession fears, inflation expectations eased late in the week
On Friday, US inflation expectations, as measured by the University of Michigan consumer sentiment survey, declined to 5.2% from 5.3% over a one-year horizon and to 2.8% from 3.1% over a 5- to-10-year horizon. The Fed is particularly concerned about inflation expectations becoming untethered and will probably take comfort in the modest decline. Conversely, US retail sales rose a more-than-expected 1% in June, with core sales rising a better-than-expected 0.8%. This, combined with an upbeat Empire State Manufacturing index (+11.1 versus -2 expected), means US recession fears could ease.
EUROPEAN ECONOMIC NEWS
Energy crisis, recession fears send euro below parity
Increasing recession fears, concerns that Moscow won’t restart gas flows to Europe once maintenance on the Nord Stream 1 pipeline is complete, diving consumer and investor confidence, and political instability in Italy all helped push the euro below $1.00 at several points during the week. Interest rate differentials are also a drag, with futures markets predicting a more muted tightening cycle from the European Central Bank than the one underway in the United States given the headwinds being faced by Europe in the wake of Russia’s invasion of Ukraine. The central bank is set to meet next Thursday and raise rates by 0.25% to -0.25%. The ECB is also expected to unveil its anti-fragmentation tool that is designed to limit spread-widening between German bunds and the bonds of euro zone countries with weaker credit fundamentals, such as Italy. Like most other developed market central banks, the ECB must contend with intensifying upside risks to inflation and downside risks to growth.
Amid discontent over planned economic reforms, former European Central Bank President Mario Draghi submitted his resignation as Italy’s prime minister on Thursday after the Five Star Movement, one party in his coalition, failed to support the government in a confidence motion. Italian President Sergio Mattarella rejected his resignation and asked Draghi to try to forge a unified coalition. Another confidence vote could follow such efforts next week.
Former Chancellor of the Exchequer Rishi Sunak won the first round of balloting to replace Boris Johnson as leader of Britain’s Conservative Party.
JAPAN, CHINA, and EMERGING MARKETS ECONOMIC NEWS
COVID restrictions slowed China’s Q2 growth
China’s economy grew just 0.4% in the just-ended quarter, held back by sweeping lockdowns in some of the country’s largest population centres during the period, though economic activity in June showed an upswing. The data suggest that Beijing’s 5.5% annual growth target for 2022 is likely far out of reach. China’s slower growth pace, as it continues to grapple with the spread of COVID-19 variants, is contributing to the recent correction in global commodities prices. China’s troubled real estate market was hit with more bad news this week, with the 10th monthly fall in a row for home prices and reports that a growing number of buyers of unfinished homes have stopped paying their mortgages, depriving developers of much-needed funds. Bloomberg reported on Thursday that China is preparing a $1.1 trillion infrastructure package to spur economic growth.
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