2023 Weekly Views

Highlights

On rates

Despite continued upward pressures on 10-year sovereign bond yields, two-year yields have remained stable in the US and Germany thanks to unchanged policy rate path expectations. However, the UK two-year yield moved sharply up to 5.25%, as pronounced inflationary pressures led market participants to reprice the Bank of England terminal rate to 6%. Without surprise, UK 10-year gilts are also up to 4.74%, their highest level since 2008. On the 10-year front, US and Germany yields climbed, with US at 4.29% (highest level since 2007) and Germany at 2.70%, mostly driven by higher inflation-linked yields as recent resilient economic data in the service sector fuels the narrative of a ‘soft landing’ for the US and euro area economies. In the US, market participants inflation expectations are well anchored around 2% over the next decade, while US Treasury Inflation Protection Securities (TIPS) offer yields not seen for years. The Fed’s balance sheet has shown a renewed pick-up in the overnight reverse repurchase agreement facility (ON RRP) lately to $1’797 bn as yields on T-Bills are below or only slightly above the ON RRP rate of 5.30% offered by the Fed. It could mean that the upcoming surge in T-Bills could be less sought after by money market funds and as such lead to a decrease in banks reserves at the Fed.

Market update

Resilient consumer

The S&P 500 closed the week at 4,396.71, -2.11% lower. The Dow Jones closed at 34,500.66, -2.21%, with the Nasdaq lower by -2.59%. The volatility index VIX closed the week at 17.30 up from 14.84. The Euro Stoxx 600 slipped -3.00%.

The 10-year UST closed at 4.25% up from 4.15% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -119bps. US Corporate Bond spreads: Investment Grade widened 3bps at 191bps and High Yield widened 13bps at 426bps. German 10-year Bunds yield closed at +2.62% unchanged from a week before. In Europe, Corporate Investment Grade spreads widened 2bps at 166bps and High Yield spreads tightened 2bps at 447bps.

The US Dollar Index (DXY) appreciated +0.52% last week and closed at 103.38. The Euro closed at 1.0873 (-0.69%); the Yen depreciated -0.30%, closing at 145.39 and the Swiss Franc depreciated -0.60%, closing at 0.8820. Gold closed at $1,889.31 depreciating -1.28%. Oil was lower, Brent closed at $84.80 (-2.32%) and WTI at $81.25 (-2.33%).

Macroeconomy

Fed minutes    

The latest Fed minutes from the July meeting confirmed that the FOMC still had a tightening bias. For instance, most participants “continued to see significant upside risks to inflation, which could require further tightening of monetary policy”. The minutes also echoed Chair Powell’s focus on growth and labor markets, and whether “product and labor markets were reaching a better balance between demand and supply”. So, while inflation has been more encouraging of late, activity data that’s still strong to keep the Fed’s hawkish bias towards the September meeting. According to the minutes, a “couple” of members favored keeping rates unchanged, which is effectively in line with the June dot plot that had two dots for no further hikes in 2023. The next event in terms of monetary policy will be Jackson Hole towards the end of this week.

US economic data

US data showed remarkable resilience from the consumer sector. Retail sales started Q3 on a strong footing, rising more than expected. Headline sales came in up +0.7% in July (vs. +0.4% expected) and retail control up +1.0% (vs +0.5% exp.). This strength came with the backdrop of an expectation for consumption to shift towards services and away from goods. Part of the strength was driven by online sales and the difficulty in seasonally adjusting for Amazon Prime Day sales. Strong data have promoted sharp upward revisions to GDP, with the Atlanta Fed GDPNow model rising sharply from 4% to 5.8%. Bluechip consensus forecast has also moved up in the past month from close to 0% to 1.7%. There is considerable upside risk to Q3 real GDP growth, but the GDPNow model tends to have sizable errors early in the quarter. We had some retail earnings as well. Walmart posted a set of strong results however, shares declined as U.S. comparable store sales growth slowed and management struck a cautious tone on consumer spending. Target and Home Depot advanced following profit beats, while discount retail chain TJX jumped on increased customer traffic as many hunted for better deals

UK economic data

Both inflation and wage growth came in above expectations, fueling a rise in bond yields on the back of a repricing higher of the BoE’s terminal rate. Headline CPI inflation declined significantly, from 8% to 6.8% in July driven by favorable base effects, but core inflation remained stable at 6.9%. Average weekly earnings rose to above 8% y-o-y in July (on a 3-month average basis). However, the details were more encouraging than the headline numbers. The share of CPI items recording easing pressures increased further, with leading indicators such as PPI still consistent with an ongoing disinflation process in goods. On wages, the most recent data does look consistent with a deceleration going into H2. Still, the set of inflation data will likely keep the BoE on a tightening path, with another 25bps rate hike expected in September to 5.50%.

Japan economic data

Japanese economy expanded by 6% q-o-q saar in Q2, beating expectations. The upside surprise was mainly driven by net exports (helped by weak yen) and household residential investment, offsetting the moderation in household consumption and corporate capex. While Japanese exports dipped into negative territory in July and may continue to moderate, it stays as an outperformer among the Asian economies. On inflation front, core inflation moderated to 3.1% y-o-y in July amid falling energy prices, but underlying momentum remains which may offer support to its nominal economic growth.

China economic data

Almost all activity data for July came in below market consensus, as the property woes and weak consumption recovery staying as the major growth headwinds in China. Retail sales growth recorded the first contraction this year at -0.1% m-o-m sa in July, compared to an average of 0.5% and 0.3% in Q1 and Q2 respectively. The labor market conditions stayed challenged amid soft industrial and investment activities. Meanwhile, the authorities stopped publishing the youth unemployment rate in July –which hit its historical high of 21.3% in June. On credit front, growth of outstanding TSF (Total Social Financing) slumped to 1.4% y-o-y in July, compared to 11.1% in Q2. New medium- to long-term household loans (mainly mortgage loans) registered another negative reading this year, suggesting household continued to opt for mortgage prepayment amid a lack of confidence. The PBoC ramped up its easing efforts lately, encouraging banks to boost lending to support growth. Last week banks cut the one-year loan prime rate by 10bps to 3.45% (smaller than the 15bps cut expected) and the 5-year loan prime rate was left unchanged (vs. 15bps cut expected). In the Real Estate sector, Country Garden Holdings suspended the trading of 11 onshore bonds and Evergrande filed for US bankruptcy protection.

What to watch

• Monday: Germany PPI (July)

• Tuesday: US Existing Home Sales Change (July)

• Wednesday: US PMI (Aug.) & New Home Sales (July); Eurozone PMI (Aug.) & Consumer Confidence (Aug., prel.); UK: PMI (Aug.); Germany: PMI (Aug.)

• Thursday: US Durable Goods Order & Core (July) & Initial Jobless Claims (Aug. 18); Eurozone ECB Accounts

• Friday: US Michigan Consumer Sentiment (July) & Jackson Hole Symposium; Germany GDP (2Q) & IFO (Aug.); Japan Tokyo CPI (Aug.)