Weekly Markets Review

15th July 2024

Markets last week

Summary

• Economic conditions were ‘just right’, leading to a positive week for equity and bond markets

• The rise in equities was broad-based, which is a refreshing change from recent narrowness in which only a few companies have been responsible for gains in the index

• US inflation was milder than expected, with the monthly reading for headline inflation dipping into negative territory (-0.1%)

• The US Federal Reserve (Fed) is likely to cut rates to prevent real interest rates from rising as inflationary forces recede

• The US equity index was negative at a headline level in GBP terms throughout the week, despite the widespread positive performance. This was due to concentrated detractors and USD weakness

• Bond yields fell as analysts factored in additional interest rate cuts for the rest of the year due to lower-than-expected inflation data

• UK economic growth rebounded in May to 0.4% after flatlining in April

• The more domestically-focused FTSE 250 rose 2%, outperforming the large-cap FTSE 100 Index which managed a more muted 0.6%

• UK gilt yields fell in sympathy with US treasuries but the rebound in economic growth, alongside some hawkish comments from members of the Bank of England’s (BoE) monetary policy committee, meant UK rates were less positive than most regions

• The Japanese Yen gained 1.9% against the US Dollar following an aggressive rise on Thursday, which sparked speculation that the central bank of Japan intervened to bolster the depreciating currency for the third time in 2024

• Despite the fall at the end of the week, Japanese equities still edged into positive territory rising 0.4% in local currency terms and taking year-to-date gains to 22.3%

• The year-to-date gain is eroded to only 7.2% when converted back to GBP considering the currency depreciation year-to-date

• China’s ‘third plenum’ policy meeting began this week. This significant policy meeting, which occurs twice a decade, could signal significant shifts within country’s ruling Communist Party

• UK inflation data for June is released on Wednesday. Inflation is expected to drop below the 2% target to 1.9% year-over-year. Services inflation will be key

• The European Central Bank’s (ECB) rate decision is on Thursday. The ECB cut their main deposit rate last month and are unlikely to cut again in this meeting.
  

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Markets last week

Market environment

Like Goldilocks’ porridge, economic conditions were neither too hot nor too cold. US inflation came in below all estimates while the economy appeared in good health. As a result, equity and bond markets enjoyed a positive week. The rise in equities was broad-based - a refreshing change considering how narrow it’s been in recent weeks.

United States

US inflation was milder than expected, with the monthly reading for headline inflation dipping into negative territory (-0.1%). Core inflation also decelerated more than anticipated, slowing to 0.1% in June. While year-on-year inflation may appear sticky and above target, shelter costs are exerting a disproportionate influence. If we remove shelter costs from core Consumer Price Index (CPI), inflation is at or even below target. Furthermore, the primary driver of core inflation, unit labour cost (the cost of labour per unit of output), is currently below 2%. From this perspective the Fed will likely want to cut rates to prevent real interest rates from rising as inflationary forces recede, thus avoiding further tightening of monetary policy. This created a positive backdrop for assets worldwide.

To illustrate the recent narrowness of the equity market consider this: since mid-May, a single company, US technology company NVIDIA, has driven half of the 3.7% gain in the US index. Out of approximately 500 stocks in the index, fewer than 200 have yielded positive returns in GBP terms. However, last week’s favourable economic conditions led to a broadening of performance, with over 300 stocks seeing an increase and a more diverse contribution across the index. Smaller companies also benefitted from the market dynamic outperforming large caps.

A significant shift was observed as some of the recent market frontrunners, especially in the technology and communication services sectors, fell behind, making these the poorest performing sectors. Real estate, utilities, and materials were the best-performing sectors. After the mild CPI print, the USD depreciated by 1.3% against the pound. The combination of the dollar’s weakness and the strong shift away from the recent large-cap leaders meant that despite the widespread positive performance, the US equity index was negative at a headline level in GBP terms over the week. The market gained 0.9% in local currency and fell -0.6% in GBP terms. Most active investors in US equities will have outperformed the index last week given the broad positive performance with more concentrated detractors.

Bond yields fell as analysts factored in additional interest rate cuts for the rest of the year due to the lower-than-expected inflation data. Fed funds futures (derivatives based on the federal funds rate) are now pricing in two-and-a-half interest rate cuts for the remainder of this year, up from two at the beginning of the week. The US ten-year yield dropped 0.1% over the week to close at 4.18%, down from the year’s high of 4.7% reached in April.

United Kingdom

In the UK economic growth rebounded in May to 0.4% after flatlining in April. Manufacturing and industrial production recovered after receding in April and construction output was considerably stronger-than-anticipated accelerating 0.8% vs the consensus estimate of 1.8%. This was a recovery from -3.3% the month prior. Following the decisive election result by the Labour Party, the new Chancellor of the Exchequer, Rachel Reeves, made promises for stronger growth and announced a series of new growth-targeting measures. Promises are easier to make than to deliver but markets enjoyed the sentiment, nonetheless.

With this backdrop, UK equities continued to perform well, particularly the more domestically-focussed FTSE 250 which rose 2%, outperforming the large-cap FTSE 100 index which managed a more muted 0.6%. Utilities and real estate were the best performing sectors while energy and technology lagged.

UK gilt yields fell in sympathy with US treasuries but the rebound in economic growth alongside some hawkish comments from members of the BoE’s monetary policy committee meant UK rates were less positive than most regions last week. These dynamics mostly impacted the shortest maturities where yields ticked slightly higher. The ten-year yield fell 0.02% to 4.11%.

Japan

The Japanese Yen gained 1.9% against the US Dollar following an aggressive rise on Thursday, which sparked speculation that the Bank of Japan (BoJ) intervened to bolster the depreciating currency for the third time in 2024. The yen has fallen 10.6% vs the dollar so far this year and in recent days had fallen to its weakest level since 1986. Japan’s ‘FX tsar’ Masato Kanda, Vice Minister of Finance for International Affairs and responsible for the country’s foreign exchange policy, denied that there was any intervention and pointed to the fall in the yield gap between Japanese government bonds and US treasuries following a soft US CPI reading. Nonetheless, the evidence points to an intervention, and it’s likely that Japanese authorities used the soft US CPI print as a smokescreen to mask the activity. The BoJ has consistently maintained that it does not aim to manipulate the yen.

Following the surge in the currency on Thursday, Japanese equities fell from their all-time highs. The weak yen is benefitting Japanese companies which tend to have significant international earnings and therefore high profitability when converting overseas earnings back to the local currency. It also attracts foreign investors who can buy more yen-denominated assets with their own currency when the yen is weak. Despite the fall at the end of the week, Japanese equities still edged into positive territory rising 0.4% in local currency terms and taking year-to-date gains to 22.3%. The year-to-date gain is eroded to only 7.2% when converted back to GBP considering the currency depreciation year-to-date.

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The week ahead

Monday: China's 'third plenum' policy meeting

Our thoughts: China’s highest-ranking officials convened for the ‘third plenum’, a significant policy meeting that will shape the course of structural reforms. This meeting, which occurs twice a decade and began today has sometimes signalled significant shifts within the Communist Party. The four-day event coincides with the government’s release of data that reflects a struggling recovery, including GDP growth for the second quarter below expectations.

Wednesday: UK Inflation

Our thoughts: Inflation is expected to drop again in June and below the 2% target to 1.9% year-over-year. Services inflation remains elevated and has proven sticky in recent months. This will be the key part of the data this week as it’s the main barrier to interest rate cuts for the BoE. Services inflation is anticipated to fall marginally to 5.6%. Currently the market anticipates the first interest rate cut in November but with a high likelihood of a cut in either August or September meetings. Given the comments from monetary policy committee members last week it’s clear that interest rate cuts are actively debated, and monetary policy is not a done deal. This week’s labour statistics will also be an important indicator of cost pressures and there’s an expectation that we will see some further softening here too.

Thursday: ECB rate decision

Our thoughts: The ECB cut their main deposit rate last month and are unlikely to cut again in this meeting. The governing council are aiming to cut rates twice more this year but will need to see further softening of wage growth to facilitate those cuts. Analysts will be looking for further insight from President Lagarde this week.

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