As we approach the second half of 2023, inflation and interest rates remain the key drivers of markets across the globe. Investors are keeping a close eye on central bank action, along with interest rate guidance to gauge their next moves. This week, The United States (US) Federal Reserve (Fed), Bank of England (BoE), Central Bank of the Republic of Turkey, and the Peoples Bank of China (PBoC) took center stage.
Key themes for this week include:
- Two rate hikes and a rate cut, along with the Fed Chair’s testimony, leaves markets feeling uncertain
- US jobless claims at highest level since October 2021
- Gold and oil dips on the back of hawkish central banks, while anticipated Chinese stimulus boosts copper
Global central banks all in focus
In a surprising move, the BoE increased its policy interest rate by 50 basis points to 5.0% during its June meeting. This marks the thirteenth consecutive rate hike by the central bank. The decision caught the markets off guard as expectations were for a smaller 25-basis-point rate increase. As a result, UK borrowing costs have reached their highest level since the 2008 financial crisis, as persistently high inflation remains a major concern for UK policymakers.
The decision to raise UK interest rates comes in the wake of the latest data, which revealed that British inflation remained stable at 8.7% year- on-year in May. This reading defied predictions of a slight decline to 8.4% and remained significantly above the central bank’s target inflation rate of 2%. Additionally, the core inflation rate, which excludes volatile food and energy prices, accelerated to its highest level in 31 years, reaching 7.1%. These figures indicate a serious inflationary issue that the BoE aims to address aggressively. The central bank’s rate hikes began almost a year and a half ago, making it the first major central bank to take such decisive action. This series of rate increases represents the most rapid policy tightening in over three decades.
Meanwhile, Turkey’s central bank surprised markets by raising its benchmark one-week repo rate by 650 basis points to 15%. This decision resulted in Turkish borrowing costs reaching their highest level since November 2021. Markets, however, anticipated a much larger hike, which would have seen interest rates rise to 21%. This move, albeit a much smaller hike than expected, signifies a departure from President Tayyip Erdogan’s unconventional economic policies, and follows the appointments of Hafize Gaye Erkan as the head of Turkey’s central bank and Mehmet Simsek as the new Treasury and Finance Minister, which will see Turkey’s monetary policy shift to a more orthodox stance.
The Turkish central bank’s decision to initiate the monetary tightening process aims to establish a trajectory of lower inflation as quickly as possible. It also seeks to anchor inflation expectations and regain control over pricing behaviour. Looking ahead, policymakers stated that Turkish monetary policy will be further strengthened as necessary, in a timely and gradual manner, suggesting a commitment to implementing additional measures if needed to address inflationary pressures and ensure economic stability. Something that the Turkish economy is in desperate need of. The Turkish lira, however, fell by 4% – to near all-time lows – which expressed the markets disappointment in the smaller than expected hike.
On the other side of the globe, in an effort to boost underwhelming economic growth, the Chinese central bank made its first reduction to two key lending rates since August 2022 during the June fixing. The one-year loan prime rate, which is used for corporate and household loans, was lowered by 10 basis points to 3.55%, while the five-year rate, which serves as a reference for mortgages, was also reduced by 10 basis points to 4.2%, aligning with market expectations. This rate cut follows two previous easing decisions made last week, indicating that more stimulus measures from Beijing can be expected. The Chinese cabinet convened last Friday to discuss strategies aimed at supporting the economic recovery, including increased financing support for technology companies and the development of regulations for supervising private funds.
Meanwhile, various global investment banks, including Goldman Sachs, have recently revised China’s 2023 gross domestic product (GDP) growth forecasts downward, due to weak economic data in May. The Chinese economy is also grappling with a consistent disinflationary trend, characterised by sluggish consumer and business spending.
In the US, Fed Chair, Jerome Powell, was also in the hotseat this week as he appeared before the House Financial Services Committee as part of his semi-annual report to Congress. His testimony followed the US central bank’s decision to pause its aggressive rate-hiking campaign, which had been one of the most significant in decades. The testimony addresses several concerns:
- Powell reiterated that inflationary pressures continue to be a concern, and the process of bringing inflation down to the target rate of 2% will take time. He suggested that further rate hikes, or at least maintaining current rates, are on the table as potential actions by the Fed.
- Discussions with Democrats highlighted their emphasis on the Fed’s mandate to achieve full employment, as they expressed concerns about potential job losses if the central bank goes too far in its efforts to combat inflation. Powell addressed the concern by reaffirming the central bank’s commitment to successfully fight inflation while also acknowledging the importance of the employment mandate. He emphasised that the labour market remains strong according to various measures.
- Republicans, on the other hand, raised questions regarding forthcoming banking regulation – due to the fallout from increased pressure due to rising interest rates – and what that could potentially mean for the economy. Powell stressed that a change in banking regulation is a lengthy process that will require input from various stakeholders.
Looking ahead, the Fed’s decision during its upcoming meeting in late July will depend on economic indicators in the coming weeks. Powell suggested that no significant new information is expected, but the Fed will continue to evaluate the situation. He noted that holding rates steady was deemed a “prudent” move, considering research showing that it takes time for rising interest rates to impact the broader economy. Powell also reiterated that monetary policy has a lag effect on the economy, making it challenging to pinpoint precisely when rising interest rates will effectively bring inflation in line with target levels.
Additionally, this week saw the Swiss and Norwegian central banks also raised their borrowing costs by 25 basis points and 50 basis points, respectively.
DATA IN A NUTSHELL
In the week ending 17 June, the number of Americans filing for unemployment benefits stood at 264,000, surpassing market expectations and matching the previous week’s upwardly revised figure. This marks the highest level since October 2021. The data aligns with recent indicators suggesting a slight weakening in the US labour market as businesses begin to experience the effects of the US’s aggressive tightening measures. The four-week moving average, which smooths out weekly fluctuations, increased by 8,500 to 255,750.
Consumer price inflation in the United Kingdom (UK) remained unchanged at 8.7% in May 2023, matching the 13-month low recorded in the previous month. This figure exceeded market expectations of 8.4% and remained significantly higher than the BoE’s target of 2%. The increase in prices for air travel, recreational and cultural goods and services, and second-hand cars offset the decline in fuel costs and the slower food inflation. Additionally, the core inflation rate, which excludes volatile items, reached 7.1%, its highest level since March 1992.
The composite leading business cycle indicator in South Africa continued its downward trend, dropping by 1% in April 2023. This marks the third consecutive month of declines, with seven out of the 10 available component time series showing decreases. The narrowing interest rate spread and a decline in the RMB/BER Business Confidence Index were the major negative factors. On the positive side, there were improvements in the six-month smoothed growth rate of job advertisements and real M1 money supply. Meanwhile, South Africa’s annual inflation rate reached a 13-month low of 6.3% in May, down from 6.8% in April and below market expectations of 6.5%. The slowdown in inflation brought it closer to the upper limit of the South African Reserve Bank’s (SARB’s) target range of 3% to 6%. Price deceleration was mainly driven by food and non-alcoholic beverages, transportation, household contents and services, alcoholic beverages and tobacco, and recreation and culture. The annual core inflation, which excludes volatile food and energy prices, also eased to 5.2% in May.
INTEREST WOES WEIGH ON EQUITIES
On Thursday, the S&P 500 saw a modest increase of 0.1%, while the Nasdaq gained 0.5%. The Dow Jones, on the other hand, remained mostly flat. Traders closely monitored Powell’s testimony before Congress, where he reiterated the need for higher rates to address high inflation numbers, suggesting that two more rate hikes this year were likely. In terms of individual stocks, electric car manufacturer, Tesla, saw its shares recover by nearly 1% following a downgrade by Morgan Stanley. Technology company, Nvidia’s shares added 0.5% after a slight decline, while online retailer, Amazon, surged over 3% to reach a 40-week high. Conversely, aircraft manufacturer, Boeing’s shares were down about 3%, and Spirit AeroSystems dropped over 10% due to a worker strike and subsequent production halt at the largest first-tier-aerostructures manufacturer.
Thursday also saw the UK’s FTSE 100 falling by nearly 1% to reach three-week lows at 7,480. Investor reaction followed the BoE’s decision to raise interest rates by 50 basis points, exceeding expectations for a smaller 25 basis point hike. The decision was influenced by a higher-than-expected inflation figure. Policymakers also indicated their commitment to further rate hikes if inflationary pressures persist. Traders now anticipate a peak rate of 6.05% by February 2024, up from 5.9% before the policy decision. Homebuilders and banks were among the worst-performing sectors. Conversely, shares of technology company, Ocado, saw a significant surge of around 35% following reports of potential interest from Amazon for a bid on the company.
European equity markets also experienced a decline of over 1% as investors expressed concerns over interest rates and the overall economic outlook. The BoE and Norway’s central bank, Norges Bank, surprised the markets by implementing a larger-than-expected 50 basis point rate hike, while the Swiss National Bank also raised rates and hinted at potential future increases. Persistent inflation, particularly in core measures, remains a challenge for the region. The automotive industry faced significant losses, dropping by nearly 2%, closely followed by banks. The benchmark STOXX 600 index was down 1.1%, and the German DAX shed 0.7%.
The Japanese Nikkei 225 Index declined by 0.92% to close at 33,265, while the broader TOPIX Index had a marginal increase of 0.06% to reach 2,297. Japanese stocks struggled for direction as investor sentiment was impacted by Powell’s statement indicating the likelihood of further US rate increases due to persistently high US inflation. However, the benchmark indices remained close to their highest levels in 33 years, supported by strong domestic earnings and a weakening yen, which helped Japanese shares outperform global peers. Technology stocks, including SoftBank Group, Advantest, Tokyo Electron, Renesas Electronics, and Keyence, experienced losses as they tracked the decline in the Nasdaq. In contrast, index heavyweights such as Mitsubishi UFJ, Toyota Motor, Sumitomo Mitsui, Nintendo, and Mitsui & Co registered strong gains.
South Africa’s JSE FTSE All Share index continued its decline for the fourth consecutive session, trading below the 75,100 level. Negative sentiment was influenced by global market trends following Powell’s warning about potential future US interest rate hikes. Sectors linked to resources, industrials, and financials were among the weakest performers. Additionally, South African fashion retailer, Mr Price, reported a 6% decrease in annual profit and lower like-for-like sales in its latest year-end results. The company attributed these results to the impact of increased inflationary pressure, higher interest rates, and power cuts on consumer behaviour.
EXPECTED CHINESE STIMULUS PULLS COPPER HIGHER
Oil prices experienced a nearly 2% decline on Thursday, with West Texas Intermediate Crude futures trading at around $71/barrel. The fall in price was driven by concerns arising from hawkish messages delivered by major central banks, which heightened worries about extended periods of higher interest rates and their potential impact on demand. On the flip side, some positive factors included a decrease in US crude inventories according to American Petroleum Institute data, indicating potential supply limitations due to muted increases in US oil output and production cuts by the expanded Organization of the Petroleum Exporting Countries, OPEC+. These factors could contribute to upward pressure on oil prices in the coming months. Official data from the US Energy Information Administration, due out today, is expected to provide further insights.
Gold prices declined towards $1 925/ounce, reaching their lowest level in over three months, amid the ongoing hawkish stance of major central banks that continue to impact the demand for gold as investors favour interest-bearing assets. Expectations of further interest rate hikes by the Fed this year, coupled with the BoE’s decision to raise its borrowing cost by 50 basis points, are contributing to the higher opportunity cost of holding gold.
Copper futures climbed towards $3.90/pound, reaching their highest level in over a month, with key factors contributing to this increase including a weaker dollar, supply concerns, and expectations of improved demand from, specifically, China. Market experts expressed concerns about potential copper supply shortages in the face of growing long-term demand, particularly for renewable energy production, while expectations of stimulus measures in China, to boost the country’s industrial sector, bolstered the price. The PBoC also reduced its short-term borrowing costs to enhance liquidity for property developers. On the supply side, copper inventories at the London Metals Exchange reached a one-month low of under 72,000 tonnes in June. Chile also anticipated a decline of up to 7% in copper output for the year, following a 10.6% decrease in 2022.
RAND CLAWS BACK LOST GROUND, BEFORE LOSING IT AGAIN
This morning, the dollar index moved above 102.5, continuing its increase from Thursday, on the back of global central banks taking strong measures to control inflation. Indications are that they will continue to do so, with the Fed Chair stating earlier this week, in his testimony to Congress, that he expects further US interest rate increases. Action by central banks is worrying investors about the state of the global economy and is driving demand for safer assets like the dollar.
The euro climbed above $1.10, reaching its highest level in six weeks, driven by expectations of higher interest rates from the European Central Bank (ECB) and other major European central banks. Concerns about elevated inflation levels in the region supported this trend. The ECB has already raised interest rates for the eighth consecutive time and signaled the possibility of another hike in July. Additionally, the BoE and the Norges Bank surprised the markets with larger-than-expected rate hikes, while the Swiss National Bank increased its policy rate for the fifth time and hinted at further increases.
The British pound remained relatively unchanged below $1.28 after initially experiencing some gains, as investors processed the BoE’s monetary policy decision. The decision was influenced by a higher-than-anticipated inflation reading for May, which increased the likelihood of a larger rate increase. Furthermore, policymakers emphasised that if there were signs of enduring inflationary pressures, borrowing costs could continue to rise.
Yesterday, the rand lost 1% of its value against the US dollar, and around 0.80% against both the British pound and the euro. The South African rand was trading at around R18.60/$, down from a one-month high of R18.20/$ reached on 19 June. The currency remains at risk of further declines over the weekend, as market sentiment remains cautious, however, it is unlikely to experience a significant reversal of its recent gains. There could be a move towards the R18.78/$, R20.42/€, and R23.75/£. This depreciation is being influenced by the strengthening of the US dollar, as well as investor concerns about the possibility of a pause in local interest rate hikes. South Africa’s annual inflation rate decreased by more than expected to a 13-month low of 6.3% in May, down from 6.8% in April, approaching the upper end of the SARB’s target range of 3% to 6%. Inflation is expected to continue decreasing, with a more significant decline expected in July due to the base effect, considering the peak of 7.8% in July 2022. Since November 2021, the SARB has raised interest rates ten times, totalling 475 basis points, in an effort to bring inflation back to its preferred level of the midpoint at 4.5% and anchor expectations
The rand is trading at R18.61/$, R20.33/€ and R23.68/£.
Sources: Trading Economics and Reuters