Key themes over the year, including stubbornly high inflation, slowing global growth, rising interest rates, geopolitical concerns in Eastern Europe as well as China’s zero Covid-19 policy have continued to dominate the headlines over the month of July. Central bank activity remained assertive with recent rate hikes in the US, Europe and South Africa coming in at or ahead of expectations.
Global equities, however, began to recover towards the latter part of the month following the release of US inflation data. The US headline inflation came in at 9.1% in June, the strongest reading since 1981. The market has now shifted its focus to how quickly inflation starts to unwind, assuming it is at or close to its peak. Therefore, the market has swung from inflation being a major headwind, to economic weakness being the new area of concern, which was amplified by a second consecutive quarter of negative US GDP growth. Commentary from US Federal Reserve Chair Jerome Powell noted that the committee would exercise caution going forward and likely slow hikes at some stage to avoid a deep recession while still keeping economic growth suppressed. The market expects the US Federal Reserve to pivot sooner than previous forecasts, with cuts now expected towards the middle of 2023. US equities, which were up ~6.4% towards month end, also gained support from a batch of resilient company earnings which helped to partially alleviate risk-off sentiment.
In an unexpected turn of events, the European Central Bank (ECB) hiked rates for the first time in more than a decade, going against forward guidance. The central bank raised all rates by 50 basis points and not 25 basis points, ending the negative interest rate policy (NIRP). In terms of performance, the STOXX Europe 600 Index performed like most global markets, gaining ~5.9%.
Looking at the Asia-Pacific region, the gradual re-opening of the Chinese economy following strict Covid-policies and generally upbeat economic data has also bolstered risk-on sentiment. Returns across the regions lagged compared to other global equities, with most key indices trading down in excess of 5%. This was spurred on by broad weakness in the tech sector due to ongoing regulatory scrutiny, headwinds associated with the earlier Covid-19 related restrictions as well as recent mortgage boycotts which have impacted an already constrained property sector. Policymakers, however, remain committed to stabilising the property market with the local government expected to coordinate with relevant stakeholders in resolving the issue between cash-strapped developers who are unable to complete residential projects and the disgruntled buyers of pre-sold homes.
Outlook
- We remain cautious on the returns for global equity markets as the supportive monetary and fiscal policy that helped propel equities last year continues to fade.
- Hawkish rhetoric from the US Federal Reserve compared to other major central banks has helped increase the relative attractiveness of the dollar.
- Developed market consumption expenditure is expected to be more muted amid lower savings rates, subsiding government transfer payments, and as real disposable income is eroded by inflationary pressures.
- The partial re-opening of the Chinese economy and recent upside surprises to economic data are welcomed. While we are cautious of sudden lockdowns being erected, low relative valuations compared to other equity regions are making the investment case attractive.
- The transition from stagflation to recessionary fears is starting to reflect in broader commodity prices as the global economy continues to slow.
- While price pressures remain sticky, particularly against the backdrop of elevated tensions between Russia and Ukraine, we continue to believe that the inflation profile will subside in the second half of the year.
- We believe inflationary pressures will dissipate toward the end of the year as we assume supply chain bottlenecks will likely unwind as trading conditions normalise. Increasing headwinds for consumer demand will also likely add to disinflationary pressures as high staple prices such as food and energy erode real consumption expenditure prospects. Moreover, more favourable base effects will likely assist in lowering year-on-year CPI prints.
The US headlines dominated by inflation, interest rate hikes and a second consecutive quarter of negative GDP growth
The S&P Global Composite Purchasing Managers' Index (PMI) for the US was revised lower to 52.3 in June 2022, down from a final reading of 53.6 a month before, signalling a solid contraction in private sector output, as both manufacturers and service providers reported subdued demand conditions. Ahead of expectations though, retail sales increased 8.4% year-on-year, from an upwardly revised increase of 8.2% in May. The trade deficit narrowed to a five-month low of $85.5 billion in May, above market forecasts of an $84.9 billion gap, as exports hit a record high, while soaring prices and slowing domestic demand weighed on imports. The unemployment rate was unchanged at 3.6% in June, in line with forecasts. Annual inflation increased unexpectedly to 9.1%, the highest the US has seen in over 40 years. The Federal Reserve raised the target range for the fed funds rate by 75 basis points to 2.25%-2.5% during its July 2022 meeting, the fourth consecutive rate hike, pushing borrowing costs to the highest level since 2019, matching market forecasts. The US economy shrank 0.9% on an annualised basis in quarter two of 2022 against expectations for growth of 0.5%, following a 1.6% drop in the first quarter – technically entering a recession.
Eurozone inflation reaches record high – ECB hikes rates for the first time in more than a decade
On a preliminary basis, the S&P Global Eurozone Composite PMI fell to 52 in June, reflective of the first contraction in private sector activity since February 2021. This is, however, still ahead of the market consensus of 51.9. The Eurozone posted a trade deficit of €26.3 billion in May 2022, compared to a surplus of €12 billion in the same period a year ago, as imports surged 52% year-on-year, while exports rose at a softer 28.9% year-on-year. Better than expectations, the unemployment decreased to 6.6%. Annual inflation for June was confirmed at a record-high 8.6% due to a broad increase in the price of energy, food, alcohol & tobacco, and services. The ECB raised its three key interest rates by 50 basis points during its July 2022 meeting, the first increase since 2011, ending eight years of negative rates, in an attempt to release the inflationary pressures. The main refinancing rate is now at 0.5%, the marginal lending facility at 0.75% and the deposit facility one at 0%. The central bank had initially committed to a 25 basis points rate hike in the June meeting, but inflationary risks continue on the upside and policymakers considered it appropriate to take a larger first step.
Mixed data out of the UK with inflationary concerns at the forefront
According to preliminary reports, the S&P Global/CIPS UK Composite PMI decreased to 52.8 in July, lower than the forecasted 53, reflective of softer demand, alongside ongoing capacity constraints arising from shortages of materials and staff. Retail sales volumes decreased 5.8% year-on-year, compared to estimates of a 5.3% decline. The trade deficit narrowed to £9.7 billion in May, from £9.8 billion in the previous month, as imports rose less than exports. The unemployment rate was in line with expectations of 3.8%. Annual inflation increased to 9.4%, above expectations of a 9.3% increase in June. During its June 2022 meeting, the Bank of England (BOE) raised the key Bank Rate by 25 basis points to 1.25%, a fifth consecutive rate hike, pushing borrowing costs to the highest in 13 years as it tries to temper soaring inflation. The central bank now expects inflation to be over 9% during the next few months and to rise to slightly above 11% in October while GDP growth is seen slowing sharply over the first half of the forecast period.
China saw a rebound in economic data amid easing Covid-control measures
China’s composite PMI surged to 55.3 in June, from a final 42.2 a month before, and was well above market forecasts of 50. Retail sales increased unexpectedly by 3.1% year-on-year, ahead of market expectations (Trading Economics: flat). The trade surplus jumped to a record high of $97.9 billion, compared to $50.1 billion over the same period a year ago, beating the forecasted surplus of $75.7 billion. Exports were up 17.9% year-on-year, while imports rose at a softer 1%. The surveyed urban unemployment rate declined to 5.7% in June amid the government’s continued efforts to revive the economy by easing Covid-19 restrictions. China’s annual inflation rate increased ahead of expectations to 2.5% as food prices rose the most in over 20 months.
Japan maintains interest rates but downwardly revised GDP growth forecasts
Flash estimates showed that the Jibun Bank Composite PMI reading for Japan fell to 50.6 in July 2022, from a final 53 in the previous month. This was slightly behind expectations as private sector growth moderated. Retail sales for May increased 3.6% year-on-year, boosted by stronger consumption as all Covid-19 restrictions in the region were momentarily eased. This exceeded the market consensus of 3.3%. Japan posted a trade deficit of ¥1.4 trillion, compared to a surplus of ¥370 billion over the same period a year ago. This was, however, still better than the estimated gap of ¥1.5 trillion. The unemployment rate increased unexpectedly to 2.6% as the total number of unemployed persons went up by ~40 000. As widely expected, the Bank of Japan (BoJ), maintained its key short-term interest rate at -0.1% and reiterated its target for the 10-year government bond yield at ~0%. The bank, however, has cut its 2022 GDP growth forecast by 50 basis points down to 2.4%, citing a slowdown in global economies and prevailing supply chain issues due to the War in Ukraine. Policymakers have also asserted that the BoJ will not hesitate to take extra easing measures if needed.
Outlook
In South Africa, data was slightly weaker
The seasonally adjusted Absa PMI Index decreased to 52.2 in June from 54.8 in May. The latest reading pointed to the eleventh straight month of expansion in manufacturing activity. The S&P SA PMI rose to 52.5 in June from 50.7 in May, pointing to the fastest expansion in the country’s private sector activity since May last year. Private sector credit grew by 5.34% year-on-year in May, after a revised 5.87% gain a month earlier. This marked the eleventh straight month of increase in private sector credit.
The value of recorded building plans passed fell by 7.6% from a year earlier in May, compared to an upwardly revised 8.6% plunge in April. Retail trade rose by 0.1% in May, following an upwardly revised 4.3% rise in April. The trade surplus expanded to R28.35 billion in May from an upwardly revised R16 billion in April. Exports rose 17.8% while imports rose at a softer 10.9%.
Mining production shrank by 7.8% year-on-year in May, after a downwardly revised 14.8% fall in the previous month. It marks the fourth consecutive month of a downturn in mining activity, pressured by load-shedding and striking activity in the gold sector. Manufacturing production fell by 2.3% year-on-year in May, after a revised 7.6% decrease in April but better than market expectations of a 2.4% drop.
Consumer price inflation accelerated to 7.4% in June, from 6.5% in May, above market expectations of 7.2% and above the SARB’s target range of 3-6%. It was the highest reading since May 2009, as prices continued to accelerate mostly for transport (fuel) and food. Core inflation, which excludes prices of food and energy, rose to 4.4% in June, the highest since March 2019, from 4.1% in the previous month.
The South African Reserve Bank (SARB) raised the repo rate by a more than expected 75 basis points to 5.5% at its July meeting to contain domestic inflation. Three members voted for 75 basis points, one member for 50 basis points and one member for 100 basis points. Further hikes were also signalled. Inflation forecasts were revised higher with risks assessed to the upside. The BER inflation expectations report released on the same day as the meeting also showed a concerning upward trend. Expectations for 2022 have moved from 5.1% to 6%, while for 2023 and 2024 it moved from 5% to 5.6%, and from 5% to 5.4%, respectively. The next meeting is in September.