Definition: flip-flop. verb [I] US informal uk /ˈflɪp.flɒp / us /ˈflɪp.flɑːp /. to change a plan completely.
If we have learned anything from investor behavior over the past few months, it is that sentiment is fickle. Risk appetite is here today, and gone tomorrow, with markets positioning and repositioning at every slight deviation in central bankers’ tone, or an even “somewhat relevant” data release. This week was no different. Markets made a swift flip-flop from betting on “more hikes to come” to “we are at, or very close to the peak”.
Key themes for this week include:
- Softer United States (US) Inflation see markets pivot into a risk rally
- Weak trade data raises concerns over China’s economic recovery
- Equities rally on the back of expectation of US Federal Reserve (Fed) rate pause
- Rand strengthens as dollar loses ground
DANCING TO THE TUNE OF THE DATA
Just two weeks ago, we heard hawkish commentary from the US Fed officials at the European Central Bank (ECB) banking forum. This followed robust US GDP data that topped market expectations. The US dollar gained ground, forcing many riskier currencies weaker, yet again. Today, however, we find ourselves on the opposite side of the spectrum once again.
The softer than expected non-farm payrolls released last week Friday, which saw the US add the lowest number of jobs in two and a half years, coupled with a softer inflation reading earlier this week, have investors flip-flopping to the other side of the argument. They are now repositioning for interest rates to peak soon. In June, the annual inflation rate in the US decreased to 3%, marking the lowest level since March 2021. This slowdown can be attributed partially to a high base effect from the previous year, when energy and food prices surged, causing the headline inflation to reach a peak at 9.1%, a number not seen since 1981. Energy costs dropped notably by 16.7%, with significant declines in fuel oil, gasoline, and utility gas service prices. The core inflation rate, which excludes volatile food and energy prices, fell to 4.8%, reaching its lowest level since October 2021.
This dance with data is nothing new to markets. They remain volatile, as they try to anticipate the next moves from key central banks, based on the key data releases, as everyone is trying to guess what the terminal rates will be and then try and predict potential rate pause, and then cuts by, specifically, the Fed.
However, as the saying goes, we shouldn’t count our chickens before they hatch. The Fed will likely seek further proof that inflation has been effectively controlled, but there is no doubt that a clear downward trend has now been established, and while peak rates might be in sight, the cutting of interest rates is likely still quite a way off.
DATA IN A NUTSHELL
The number of Americans applying for unemployment benefits increased by 12,000 to reach 248,000 in the week ending 1 July, which was in line with expectations of 245,000. Despite the slight uptick, the figure remained significantly lower than historical averages and the recent peaks in June, indicating a tight labour market. The four-week moving average, which smooths out weekly fluctuations, decreased by 3,500 to 253,250. On an unadjusted basis, unemployment claims rose by 20,838 to 250,556, with notable increases in Michigan and New York. In contrast, continuing claims decreased by 13,000 to 1,720,000 in the previous week, marking the lowest level in four months and suggesting improved conditions for jobseekers to find employment. Both headline and core producer prices in the US saw a slight 0.1% increase from the previous month in June, falling below market expectations. This aligns with the softer-than-expected CPI data from the same period. Currently, financial markets anticipate a 25 basis points increase in the US central bank’s funds rate in the upcoming meeting, followed by no further changes for the remainder of the year. There is a projected shift towards a more dovish stance in the first quarter of 2024.
The United Kingdom’s (UK’s) unemployment rate climbed to 4.0% from March to May, reaching its highest level since late 2021 and surpassing market expectations of 3.8%. The number of unemployed individuals rose by 77,000 to 1.37 million, primarily driven by those who had been jobless for up to 12 months. Employment levels, on the other hand, increased by 102,000 to 33.05 million, largely driven by part-time workers but fell short of the market consensus of a 125,000 rise. Wages, excluding bonuses, experienced a significant year-on-year increase of 7.3% during the three-month period ending in May, the largest growth seen outside of the COVID-19 pandemic, exceeding forecasts of 7.1%. Moreover, total pay growth accelerated to 6.9%, surpassing expectations of 6.8% The UK economy experienced a 0.4% year-on-year contraction in May, marking the first decline since 2021. This result was better than the market’s expectations, which predicted a 0.7% decline.
China’s consumer prices unexpectedly remained flat in June, falling short of market expectations and the previous month’s 0.2% increase. This marked the lowest reading since deflation was observed in February 2021, primarily driven by a decline in non-food prices. Transportation costs continued to decrease, while the growth rate of education expenses slowed. Health-related inflation remained stable, and housing prices remained unchanged following a slight decline. On the other hand, food prices experienced their highest increase in three months, driven by a rebound in the costs of fresh vegetables and eggs, despite a significant drop in pork prices. Core consumer prices, excluding food and energy prices, rose by 0.4% year-on-year, their lowest level since March 2021. Monthly consumer prices unexpectedly declined by 0.2%, marking the fifth consecutive month of falls, contrary to consensus expectations.
Manufacturing production in South Africa expanded by 2.5% year-on-year in May, following a strong 3.6% increase the previous month and surpassing market forecasts of a 2.3% rise. This marks the second consecutive month of growth in industrial activity, driven by the manufacture of motor vehicles, parts, accessories, and other transport equipment, as well as basic iron and steel production. However, output slowed for food and beverages and declined for furniture, other manufacturing sectors, and petroleum, chemical, rubber, and plastic products. Local mining production unexpectedly contracted by 0.8% year-on-year, following a revised 3.2% increase in April. The largest negative contributors were PGMs (platinum group metals) and diamonds, with significant declines also seen in other non-metallic minerals, building materials, nickel, chromium ore, and iron ore.
EARNING SEASON TAKE CENTRE STAGE
On Thursday, the Dow Jones increased by nearly 100 points, while the S&P 500 rose 0.6% and the Nasdaq gained 0.9%. This was driven by the start of the earnings season, with Delta Airlines reporting record revenue and earnings for the second quarter, leading to a 3% jump in its shares. Beverage manufacturer, PepsiCo, also exceeded expectations, causing its stocks to rise by over 1%. Big banks like JPMorgan, Wells Fargo, and Citigroup are expected to release their quarterly results tomorrow. Additionally, online retailer, Amazon’s shares reached a 43-week high of $133.96, rising 2.6% after reporting record sales during its Prime Day sale.
Meanwhile, the UK’s FTSE 100 index increased by 0.3% for the fourth consecutive session. This growth was supported by gains in industrial miners, which rose by 2%, and positive news from official data showing that the contraction in Britain’s economy in May was milder than expected. However, homebuilders experienced a decline of 0.8%, with Barratt Developments down 1.6% after announcing plans to reduce the construction of homes by around 20% in 2024.
European equity markets closed higher, with the DAX in Frankfurt rising by 0.7% and the pan-European STOXX 600 gaining 0.6%. This was driven by recent data showing a slowdown in inflationary pressures in the US. In other news, the ECB’s meeting minutes for June revealed that policymakers are open to raising interest rates beyond July, if the need arises.
On Thursday, Japan’s Nikkei 225 Index surged by 1.49% to close at 32,419, while the broader TOPIX Index gained 0.97% to reach 2,243. This rise followed a rally on Wall Street, driven by cooler-than-expected US inflation data, which raised hopes that the Fed is nearing the end of its tightening cycle. Investors also showed renewed interest in technology stocks after a period of consolidation, with notable gains seen in SoftBank Group, Advantest, Socionext, Tokyo Electron, Z Holdings, and Renesas Electronics. Other major companies like Sony Group, Fast Retailing, Daiichi Sankyo, Mitsui & Co, and Eisai Co also experienced advances in their share prices.
South Africa’s JSE FTSE All Share index continued its early gains and closed approximately 1% higher at 77,317, reaching its highest level in over three weeks. The upward movement was mainly driven by strong performances in heavyweight tech company Prosus, resource-linked sectors, and financials. Positive economic data contributed to improved market sentiment, raising hopes for a pause in the Fed’s rate hikes after this month. However, disappointing Chinese trade data raised concerns about the global economic activity’s pace.
EXPECTED FUTURE DEMAND INCREASES BOLSTER OIL
On Thursday, West Texas Intermediate Crude futures declined below $75.50/barrel from a two-month high as investors considered the latest oil outlook from the Energy Information Administration and the Organization of the Petroleum Exporting Countries (OPEC). The International Energy Agency revised its global oil demand growth forecast downwards for 2023 by 220,000 barrels/day to 2.2 million barrels/day. However, OPEC maintained an optimistic view on world oil demand, increasing its growth projection for 2023 and anticipating a slight slowdown in 2024, driven by strong fuel consumption in China and India. OPEC expects oil demand to rise to 2.25 million barrels/day in 2024, up from 2.44 million barrels/day in 2023. Despite production cuts, OPEC’s oil production rose by 91,000 barrels/day to 28.19 million barrels/day in June, led by Iran and Iraq. The recent rise in oil prices was influenced by lower-than-expected US inflation figures. Additionally, China’s crude imports reached a three-year high, indicating robust demand despite indications of a broader economic slowdown.
Gold remained steady at the $1 960/ounce level, reaching its highest level in a month. This was due to increased hopes that the Fed’s tightening cycle would conclude this month. This expectation limited the downside risk of holding non-interest-bearing precious metals.
Copper futures rose above $3.90/pound in mid-July, reaching their highest level since late April. This increase was driven by multiple factors, including a weaker dollar, concerns about copper shortages, and expectations of stronger demand. Declines in copper output in Chile, the top producer, also contributed to the anticipation of a supply shortfall, especially considering copper’s vital role in the global transition to sustainable energy sources. Copper stockpiles across major exchanges and warehouses have significantly decreased since March. The evidence of slowing inflation in the US has reduced expectations of hawkishness from the Fed, thereby boosting expectations of increased industrial activity worldwide and putting pressure on the dollar, which is the currency used to price commodities. Additionally, weak trade data from China has raised expectations of potential public support measures to aid the country’s economic recovery.
Interest rates dominate
On Thursday, the US Dollar Index declined, approaching the 100 mark and reaching its lowest levels in over a year. This drop was driven by speculation that the Fed might be nearing the end of its rate-hiking cycle. As a result, the dollar declined to over one-year lows against the euro and the pound, and it also depreciated to around one-month lows against the yen and other currencies from the Asia-Pacific region.
The euro continued to strengthen above $1.11/€, reaching its highest level since February 2022. While it is expected that the Fed is nearing the end of its current policy tightening, investors believe that the ECB still needs to address inflationary pressures within the eurozone, despite signs of a slowdown in economic growth and easing inflation across the region. In June, eurozone inflation reached a 17-month low of 5.5%, while the core rate remained well above the ECB’s target of 2%. Currently, interest rates in the eurozone stand at 3.5%. However, pricing in derivative markets suggests that traders expect rates to peak at slightly below 4% by the end of the year.
The British pound reached the $1.30/£ level for the first time since April 2022, as it became more appealing to investors due to the UK’s higher interest rates compared to other developed economies. At the same time, stronger-than-expected UK wage growth put pressure on the Bank of England (BoE) to continue raising interest rates. BoE Governor, Andrew Bailey, emphasised the need to address inflation, indicating the Central Bank’s commitment to its aggressive policy tightening approach.
The South African rand experienced a significant appreciation, to trade below R18.00/$, reaching its highest level since 20 April. This was driven by a weaker dollar. In South Africa, it is widely anticipated that the South African Reserve Bank will raise rates by at least 25 basis points in July to help manage inflation expectations. This would bring the repo rate to 8.5% and the prime lending rate to 12%. The central bank remains cautious, as it sees upside risks to inflation stemming from global inflationary pressures and the vulnerability of the rand.
The rand is trading at R17.94/$, 20.10/€ and 23.51/£.
Sources: Refinitiv and Trading Economics.