Global markets lacked direction in May as investors remained concerned about global growth, rate hikes, sticky core inflation numbers and negotiations surrounding the US debt ceiling. The US market was able to carve out marginal gains on the back of a robust performance by large-cap tech counters, while European equities delivered a lacklustre performance. Chinese equities came under severe pressure following a series of economic releases, which fell short of expectations. The JSE also ended in negative territory as ongoing idiosyncratic risks continued to weigh on both local and foreign flows into the market.
The US interest rate outlook remained in the spotlight, with the commentary at the US Federal Reserve’s May meeting suggesting that a pause may be considered – US Fed Chair, Jerome Powell, noted that the Fed is “getting close to or may even be there” with relation to the current tightening cycle. US inflation fell from 5% in March to 4.9% in April, the lowest reading since April 2021. Core inflation also trickled lower to 5.5% (prior: 5.6%) but remains stubbornly high and well above the Fed’s target of 2%. Concerns over the country’s debt ceiling (a legislative cap on the amount of debt that the US government is authorised to borrow) also added to the turmoil, however, a tentative agreement reached between President Joe Biden and House speaker, Kevin McCarthy, helped to temporarily alleviate market pressure towards month end. The S&P 500 had gained ~1% for the month at the time of writing. This was mainly driven by a rally in the tech sector, particularly among counters with strong demand for generative AI.
Moving across the pond, the European Central Bank (ECB) raised its key interest rates by 25bps (in line with expectations) during its May meeting - slowing the pace of policy tightening. Borrowing costs are now at their highest level since July 2008, following seven consecutive rate increases. The ECB continues to battle high inflation in the region despite a continued slowdown in economic activity, with ECB President, Christine Lagarde, confirming that the committee has more ground to cover and does not plan to pause lifting rates anytime soon. The EURO STOXX 600 was relatively flat for the month of May.
Economic Data Review
US inflation continues to trend lower, however, core CPI remains sticky
Flash estimates showed that the S&P Global Composite PMI for the US increased to 54.5 in May 2023, from a final reading of 53.4 a month before. This signalled the fastest pace of expansion in the country's private sector since April 2022, as service sector growth was accelerated by stronger demand conditions. Retail sales for April increased 1.6% y/y, higher than expectations (1.4%). In March, the trade deficit narrowed to $64.2 billion, compared to forecasts of $63.3 billion, as imports climbed at a slower pace than exports. The unemployment rate in April edged down 3.4%, lower than market expectations of 3.6%. Annual inflation slowed to 4.9%, the lowest since April 2021, and below market forecasts. The Fed raised rates by 25bps in May 2023, as expected, marking the tenth increase and bringing borrowing costs to their highest level since September 2007. Fed officials expressed uncertainty about how much more policy tightening may be appropriate and focused on the need to retain optionality. Members agreed that, in assessing the appropriate stance of monetary policy, they would continue to monitor high-frequency data and would be prepared to adjust it as appropriate.
The ECB remained hawkish as inflation ticked higher
On a preliminary basis, the HCOB Eurozone Composite PMI decreased to 53.3 in May, compared to 54.1 a month before. This was below expectations of 53.7. Retail sales in March were down 3.8% y/y, compared to forecasts of a 3.1% decline. A trade surplus of €25.6 billion was recorded in March, compared to forecasts of a $12.7 billion deficit, as exports rose 7.5% and imports fell 10%. The unemployment rate decreased slightly to 6.5%, slightly below market estimates of 6.6%. Consumer price inflation for April came in at 7%, slightly higher than the previous months reading of 6.9%. The ECB raised its key interest rates by 25-bps during its May meeting, as expected, signalling a slowing pace of policy tightening. Borrowing costs have now reached their highest level since July 2008, following seven consecutive rate increases as the ECB strives to combat high inflation despite ongoing recession risks. Additionally, President Lagarde told a news conference that the ECB had more ground to cover, and it was not pausing the rate-lifting cycle anytime soon.
The Bank of England continued to raise rates and remains open to further tightening if needed
Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 53.9 in May, missing market expectations of 54.6. Retail sales volumes decreased 3% y/y in April, compared to forecasts of a 2.8% drop. In March, the trade deficit shrank to £2.86 billion as exports dropped 1.2% and imports declined 1.8%. Slightly ahead of market expectations, the unemployment rate increased to 3.9%. Annual inflation in the UK fell to 8.7% in April, still exceeding market expectations. The Bank of England raised the bank rate by 25bps in May 2023, marking the twelfth consecutive rate increase, in line with market expectations. Policymakers added that they will continue to monitor indications of persistent inflationary pressures, including labour market conditions, wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.
Generally softer than expected numbers out of China raised some concerns
China’s composite PMI declined to 53.6 in April, from 54.5 a month before. It was the fourth straight period of growth in private sector activity as services activity-maintained momentum following the removal of strict pandemic measures. Retail sales expanded 18.4% y/y in April but missed market consensus. Better than market forecasts, the country’s trade surplus widened to $90.2 billion in April, compared to $49.5 billion over the same period a year ago, as exports rose 8.5% and imports unexpectedly dropped by 7.9%. The surveyed urban unemployment rate declined to 5.2% in April. China's annual inflation rate unexpectedly fell 0.1% in April, below consensus of 0.4%. This was the lowest print since a deflation in February 2021, with prices of both food and non-food easing further.
Inflation in Japan came in higher than expected; however, policymakers kept rates unchanged
Early estimates showed that the Jibun Bank Composite PMI reading in May rose to 54.9. This was the fourth straight month of growth in private sector activity, the steepest pace since October 2013, and the second strongest in the survey history, as a recovery from pandemic disruptions gained momentum. Retail sales for March increased 7.2% y/y, exceeding market consensus of a 5.8% gain. Japan’s trade deficit fell to ¥432.4 billion in April, compared to ¥854.9 billion in the same month last year. This was less than the estimated gap of ¥613.8 billion. The unemployment rate was unexpectedly lower at 2.6%, less than market consensus of 2.7%. Annual inflation rose to 3.5% in April, above consensus. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations, but modified guidance on its policy rate by removing reference toward the need to guard against risks from the Covid-19 pandemic and to keep interest rates at "current or lower levels".
Outlook
Global
- Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as fiscal and monetary policy, particularly in the US, will likely be on a restrictive path. In particular, the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns.
- Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. This, combined with lower savings rates, subsiding government transfer payments, and depressed real disposable income will likely erode demand.
- For now, households will likely continue utilising various credit instruments, particularly credit card debt, which is currently at all-time highs, to prop up short-term expenditure prospects.
- Nevertheless, if liquidity remains plentiful due to the emergence of various Federal Reserve facilities that have been utilised by the banking sector, this may prevent price discovery from emerging in the short-term.
- While the Fed intends to tighten financial conditions heading into 2023, these facilities have largely reversed their intent and may complicate the inflation trajectory at a later stage.
- Nevertheless, we believe that the loosening of financial conditions in recent months will likely embolden the Fed to be on a restrictive path as we progress into the year, as tightening financial conditions will be needed to bring inflation down to more sustainable levels. Similar sentiments will likely be shared by the Bank of England and almost certainly the Eurozone Central Bank, which is currently grappling with all time high core inflation.
- Talks between Republicans and Democrats have been more progressive toward the end of May and our base case remains that the debt ceiling is lifted yet again, which will ultimately prevent the US from defaulting on their sovereign debt. As such, it is encouraging to see the subsequent decline in US CDS spreads.
- More recently, China’s data on a coincident to lagging indicator basis has disappointed relative to market expectations. In addition, Covid-19 cases have re-accelerated and likely resulted in renewed investors jitters within the region given the stringent lockdowns the government has erected in the past. Nevertheless, the mobility and credit impulse data are relatively strong and do point toward an improvement in the overall growth trajectory going forward. We anticipate the recovery to certainly be a bumpy one, but with historically cheap valuations, we believe there exists meaningfully opportunities in the Chinese market.
- Once peak hawkishness of the Fed has been sufficiently priced in by market participants, and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the bond curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. At this stage, we believe that the rate cutting cycle priced in by the futures curve is premature.