Fresh inflation concerns – weekly update 8 October 2018

A look back over macroeconomic and market events for the week ending 5 October 2018. Fresh inflation concerns drove selling in both equity and bond markets last week, fuelled by signs of potential capacity constraints in the US. That adds importance to the US CPI inflation reading this week with any significant deviation likely to see a market reaction.

Strong data point from US Non-Manufacturing PMI reading

There was another strong data point, this time from the US Non-Manufacturing PMI reading, which reignited inflation fears. The headline reading from the Institute for Supply Management surged from 58.5 to 61.6, defying forecasts for a fall to 58.0 and reaching a fresh high for the cycle. While this supports the case for ongoing economic strength, the data also showed supplier delivery times and backlogs both notably higher which raised concerns that capacity constraints may start having inflationary impacts.

Such inflation concerns impacted both core sovereign bonds and equities, echoing the response to the previous inflation shock at the start of the year. It wasn’t all good news though, as the ISM Manufacturing PMI reading fell from 61.3 to 59.8, marginally worse than the 60.0 forecast.

The US Labour Market report potentially added fuel to the fire

The US Labour Market report potentially added fuel to the fire. Although the headline number of 134,000 fell some way short of the 185,000 expected, much of this was reported as being driven by weather-related factors as Hurricane Florence hit parts of the US, and this was more than offset by the upward revision for the prior two months which totalled 87,000 additional jobs.

While average hourly earnings slipped as expected from 2.9% to 2.8% year on year (yoy), it was the further-than-expected fall in the unemployment rate from 3.9% to 3.7% (3.8% expected) that raised eyebrows, putting it at the lowest rate since 1969. The usual culprit for fluctuations in unemployment, Labour Force Participation, was unchanged at 62.7% as expected.

The People’s Bank of China cut the reserve ratio by 1 percentage point

Over the weekend the People’s Bank of China cut the reserve ratio by 1 percentage point for major banks, releasing some 1.2 trillion yuan into the system, with just over a third being earmarked to repay maturing medium-term loan facilities. This is aimed at helping to contain the cooling economy as part of the authorities’ attempts to manage a soft landing of the economy. It is also likely to have mitigated losses in equity markets which were closed for a holiday last week.

Last week’s other events

• In the UK the Composite PMI reading dipped from 54.2 to 54.1, which was better than the 53.9 expected. A reasonably strong beat from the Manufacturing component, which rose from 53.0 to 53.8 versus forecasts for a fall to 52.5, helped offset the marginally worse than expected Services element (which fell from 54.3 to 53.9, 54.0 expected)
• In the Eurozone, unemployment fell from 8.2% to 8.1% as expected, while Retail Sales rose from 1.0% to 1.8% yoy (1.7% was expected)
• The Japanese Composite PMI reading slipped from 52.0 to 50.7, while Real Cash Earnings fell -0.6% yoy, from 0.4% previously and worse than the 0% forecast

The markets

It was an uncomfortable start to the final quarter as inflationary fears hit equities and bonds alike last week.

Equities

It was a tough week for equity markets, with all regions that we report on notably lower. Emerging Markets bore the brunt of the latest sell-off, with the MSCI Emerging Markets Index falling -3.7%. UK equities fell -2.4% with continental Europe down -1.7% (based on the MSCI United Kingdom and Europe ex-UK indices respectively). The Japanese TOPIX index slipped -1.4% whilst the US proved relatively resilient, down -1.0%.

Bonds

With fears of inflation mounting, especially in the US, it is little surprise that bonds were weaker alongside equities. 10-year US Treasury yields rose 17 basis points (bps) on the week, consolidating the recent moves above 3% to finish the week at 3.23%.

10-year gilt yields rose in sympathy, 15 bps higher to 1.72% by the end of the week, while the equivalent German bund yields were up 10 bps to 0.57%. 10-year Japanese Government Bond yields rose 2.5 bps to 0.16%.

Commodities

Gold pushed back up through the US$1,200 mark to finish the week at US$1,204 per ounce, while oil finished slightly stronger on the week, with Brent Crude closing at US$84.16 per barrel on Friday. Copper weakened to US$2.76 per lb.

Currencies

Amid the turmoil, sterling gained some strength on the week, up 1.4% against an especially soft euro. Sterling closed on Friday at US$1.31, €1.14 and ¥149.

The week ahead

It’s a quieter week ahead. Given the renewed fears over inflation in the US, the US CPI print on Thursday is likely to be closely watched. The expected 0.2% month on month (mom) rise translates to 2.4% yoy from 2.7% once base effects are accounted for, so a significant deviation could cause a reaction. Elsewhere, other points to watch include Industrial Production for the UK reported on Wednesday and for the Eurozone on Friday, details of which are below. The daily breakdown is as follows:

Monday: Early in the morning, the China Caixin Services and Composite PMI readings are released with the Eurozone Investor Confidence measure from sentix also out in the morning. Otherwise, it is a quiet start to the week.

Tuesday: Like-for-Like Sales from the British Retail Consortium are released a minute after midnight, followed by a raft of data from Japan, including the latest Balance of Payments data and the Eco Watchers Survey results. In the afternoon, the US Small Business Optimism reading is reported from the National Fraud Intelligence Bureau.

Wednesday: The day starts with Japanese Core Machine Orders before the UK Industrial Production release later in the morning where forecasts suggest a marginal rise from 0.9% to 1.0% yoy. In the afternoon, the US reports on the latest Producer Prices Index and Wholesale Inventories readings.

Thursday: Japan reports Bank Lending activity early on and then later in the morning the Bank of England updates on Credit Conditions and Bank Liabilities. The highlight of the week, US CPI, is reported in the afternoon and covered above. Interestingly, whilst headline CPI is forecast to slip from 2.7% to 2.4% yoy largely on base effects, core CPI, which strips out Food and Energy, is expected to rise by 0.1% to 2.3%.

Friday: Eurozone Industrial Production in the morning is expected to have fallen from -0.1% to -0.3% yoy. In the afternoon, the US will report import and export prices as well as the latest US sentiment survey results from the University of Michigan.