Global markets rallied in January as pre-holiday jitters heading into December 2022 faded. Inflation levels in the US have been steadily tapering downwards, a major factor driving investor-optimism, with market participants now expecting to see peak interest rates early in 2023. This coincided with a faster-than-expected reopening of the Chinese economy. While most risk assets delivered positive returns for the month, risk-on sentiment led to a shift in flows from developed markets to emerging markets.
In line with market forecasts, the annual inflation rate in the US slowed for a sixth consecutive month to 6.5% in December, the lowest since October 2021. It now seems that inflation peaked at 9.1% in June 2022 and the supply-side impacts which drove sharp cost increases have begun to subside and are fading into the base. The market is pricing in a pause in rate hikes in the near term with cuts expected not too long after; this is despite inflation remaining substantially higher than the US Federal Reserve’s (Fed’s) target of 2%. Overall, the S&P 500 was trading up about 6% towards month end.
European markets also started the year on a much firmer footing (Euro STOXX 50: +10.3%) as a milder-than-expected winter helped ease concerns of an energy crisis in the region. European natural gas stock levels are at an all-time high, which resulted in spot prices collapsing by around 57% since December, to levels last seen ahead of Russian’s invasion of Ukraine on 24 February 2022. Economic growth forecasts have been adjusted upward with most research houses now expecting a much shallower recession than was previously expected. Inflation remains an issue – particularly at the core. The European Central Bank (ECB) remains hawkish with peak rates expected to be seen towards the latter half of the year with a 50 basis point (bps) increase priced in for each of the next two policy meetings.
China’s full reopening came much sooner than expected, with market participants having anticipated a more gradual and phased approach. While the global economy is likely to enter a recession, or at least experience recession-like conditions, China’s robust growth prospects (fuelled by expectations of a solid Covid-19 recovery) has sparked strong flows into emerging markets and risky assets. Overall, the MSCI China Index has gained some 17.5% (Hang Seng: +14.7%) for the month with the sizable outflows from US equities to emerging markets being dominated by China.
Economic Data Review
US inflation down for a sixth month with peak interest rates in sight
Flash estimates showed that the S&P Global Composite PMI for the US increased to 46.6 in January 2023, from a final reading of 45 a month prior. This continues to point to a contraction in private sector activity. Retail sales for December were flat at 6% year-on-year, better than expectations (5%). In November, the trade deficit narrowed to $61.5 billion, compared to forecasts of $73 billion. The unemployment rate dropped to 3.5% in December, below market expectations of 3.7%. Annual inflation was confirmed at 6.5%, the lowest since October 2021, and in line with market forecasts. As expected, the Fed implemented a 50bps rate hike during its final policy meeting of 2022, duly pushing borrowing costs to the highest level since 2007. Policymakers reiterated that further rate hikes within the target range would be necessary to contain inflation.
ECB remains hawkish with peak interest rates only expected in second half
On a preliminary basis, the S&P Global Eurozone Composite PMI increased to 50.2 in January, compared to 49.3 a month previously. This was above expectations of 49.8. Retail sales in November were down 2.8% year-on-year; although forecasts had presumed a 3.3% decline. A trade deficit of €11.7 billion was recorded in November, as imports surged 20.2% year-on-year, while exports rose at a softer 18.7% year-on-year. The unemployment rate was unchanged at 6.5%, in line with market estimates. Consumer price inflation for December came in at 9.2%, slowing from 10.1% a month earlier. The ECB is set to raise interest rates by 50bps in February and March. Meanwhile, the accounts of the central bank's December policy meeting showed that some policymakers argued for a 75bps interest rate raise, as inflation was expected to remain high for a long time.
Bank of England poised to raise interest rates again … the 10th time in succession
Initial reports showed that the S&P Global/CIPS UK Composite PMI decreased to 47.8 in January, missing market expectations of 49. Retail sales volumes decreased 5.8% year-on-year in December, compared to forecasts of a 4.1% drop. In November, the trade deficit stood at £1.8 billion as imports rose 2.3%. In line with market expectations, the unemployment rate was unchanged at 3.7%. Annual inflation in the UK eased to 10.5% in December, matching market forecasts. At its December meeting, the Bank of England announced a 50bps rate hike, pushing borrowing costs to the highest level since late-2008. Looking forward, the Monetary Policy Committee (MPC) agreed that if the outlook suggested more persistent inflationary pressures, it would continue to tighten policy as necessary.
China growth revised upwards after a swift reopening of the economy
In China, the world’s second-largest economy, the Composite PMI rose to 48.3 in December, from 47 a month before. The latest print pointed to the fourth consecutive month of contraction in private sector activity, amid a spike in Covid-19 cases following Beijing’s decision to abruptly exit strict pandemic curbs. Retail sales dropped 1.8% year-on-year, significantly better than the expected 8.6% decrease. Better than market forecasts, the country’s trade surplus decreased to $78 billion in November, compared to $93.2 billion over the same period a year ago, as exports and imports fell 9.9% and 7.5% respectively. The surveyed urban unemployment rate declined to 5.5%, amid eased lockdown restrictions. Chinese inflation rose to 1.8% in December. Inflation was in line with expectations and amid a rise in food prices, even as domestic demand remained sluggish given the spike in Covid-19 infections.
Core inflation in Japan at 42-year high, increasing pressure on the Bank of Japan
Early estimates showed that the Jibun Bank Composite PMI reading in January increased to 50.8, compared to a final reading of 49.7 a month earlier; this reflected the first expansion in private sector activity in three months. Retail sales for November increased 2.6% year-on-year, below the market consensus of a 3.7% gain. Japan’s trade deficit widened to ¥1.4 trillion in December, compared to ¥603 billion in the same period a year ago. This was better than the estimated gap of ¥1.6 trillion. The unemployment rate fell to 2.5%, in line with forecasts. Annual inflation climbed to 4% in December, in line with market consensus. This was the highest rate since January 1991 and was spurred on by rising prices for imported raw commodities and yen weakness. At its December meeting, the Bank of Japan (BoJ) maintained its key short-term interest rate at -0.1%, as was expected. The BoJ reiterated that it would take extra easing measures if needed while expecting short- and long-term policy interest rates to stay at their present or lower levels.