Inflation’s long and winding road

Inflation’s long and winding road

Markets in February

February saw equities slide in the US on increased expectations that the Fed will need to push interest rates higher and keep them elevated for longer. Although GDP growth slowed to 2.7% from 2.9% in the fourth quarter, weaker than the initial estimate, indications of the resilience of the US economy such as the highest rise in new orders for nondefense capital goods excluding aircraft, a closely watched proxy for business spending plans, at 0.8% along with the biggest increase in consumer spending since March 2021, up by 1.8% in January should have had a positive impact on equity markets. However, labour market tightness, with US unemployment claims continuing to fall, and core inflation rising with the Fed’s preferred gauge, the PCE index, up 0.6% in January, have made equity markets that had been looking forward to a slow down or a halt in rate cuts by the Fed react less positively to the prospect of delayed recession than would normally be the case.

In Europe, despite sticky inflation in Germany, France and Spain, all signals that the ECB will continue on its hawkish rate path for longer than markets may have previously anticipated in January, stocks were up for the month. This may be attributable to the drop in European gas prices to EUR 50 per megawatt hour (down approximately 40% year to date and around 85% below last year’s peak) and gas storage levels remaining high due to a milder winter. The lower cost of energy is driving an improvement in consumer and business confidence.

US
S&P 500   2.31% MTD and  3.72% YTD
Nasdaq 100   0.50% MTD and  9.12% YTD
Dow Jones Industrial Average   3.51% MTD and  1.48% YTD
NYSE Composite  3.79% MTD and  1.66% YTD

Europe
Stoxx 600  1.74% MTD and  7.72% YTD
DAX   1.57% MTD and  9.92% YTD
CAC 40   2.62% MTD and  11.75% YTD
FTSE 100   1.35% MTD and  6.22% YTD
IBEX 35  3.99% MTD and  13.29% YTD
FTSE MIB  3.30% MTD and  15.22% YTD

Global
MSCI World Index  3.91% YTD
Hang Seng  4.24% YTD
Bitcoin   42.06% YTD
Ethereum   38.24% YTD

Note: MTD as of 5 pm 28 Feb 2023, YTD 4pm EST 1 March 2023

Corporate reporting season: What’s next? According to Factset, with approximately 96% of companies having reported for Q4 2022, the blended earnings decline for the S&P 500 is -4.8%. If this is the actual decline for the quarter, it will mark the first time the index has reported a year-over-year decline in earnings since Q3 2020. For Q1 2023, 76 S&P 500 companies have issued negative EPS guidance and 21 S&P 500 companies have issued positive EPS guidance. According to Refinitiv I/B/E/S data, Q4 2022 Y/Y earnings are expected to be -3.2%. Excluding the energy sector, the Y/Y earnings estimate is -7.4%. Of the companies in the S&P 500 that have reported earnings to date for Q4 2022, about 67.5% have reported earnings above analyst estimates. This compares to a long-term average of 66.3%. Revenue in Q4 2022 Y/Y is expected to be 5.7%. Excluding the energy sector, the growth estimate is 5.0%. 

The Earnings season brought some disappointment across sectors with communication services having the worst Q4 2022 earnings of all sectors, down 28.1% with second worst, materials, down 20.2%. 

The US resilience conundrumThe US economy has remained resilient to rate hikes with unemployment staying at 3.4% and claimant counts dropping. This has further fueled concerns about future Fed aggressiveness with Minneapolis Fed President Neel Kashkari, saying he is "open-minded" on either a 25 basis point or a 50 basis point rate hike in March and may consider raising beyond the 5.4% level he previously thought would be sufficient to lower inflation back to its 2% target.

Although the Fed is expected to raise rates further, so is the ECB which is battling higher inflation rates than the US. This suggests further room for upside gains in the single European currency. Sterling has benefitted from dollar weakness as commodities have started to strengthen on expectations surrounding Chinese demand and stronger activity numbers. The question of who will need to raise more and for longer is reflected in foreign exchange markets with the USD down approximately 0.3% YTD against the EUR, down 0.6% YTD against the GBP, and up about 3.8% against the YEN.

Growth stocks were mixed in February with mega caps AlphabetAmazon, and Microsoft ending the month down, Apple ending the month flat and Meta PlatformsNvidiaTesla all up. However, as the Fed and other central banks are looking increasingly likely to keep rates higher for longer, there may be a movement out of growth stocks into value as higher interest rates feed into higher discount rates, making future cash flows of growth stocks less attractive.

Oil continued to decline in February despite rising expectations of Chinese demand and Russian production cuts. Although BP and Shell were up in February, largely due to record profits, other energy companies such as Energy FuelsBaker Hughes CompanyExxonMobilApa Corp (US), and Occidental Petroleum Corporation all ended the month down.

Materials and Mining stocks had a mixed month in February with commodity stocks down 4.7% according to JP Morgan Asset Management. This hit mining stocks with Freeport-McMoranNewmont MiningSibanye StillwaterLundin Mining all down in February. However, materials stocks had more of a mixed picture as Linde plcAlbemarle CorporationYara International, and Mosaic, ended the month up and Celanese CorporationDow Chemical, and DuPont de Nemours all down. 

Europe’s ongoing inflation problems. Inflation in Europe’s largest economy, Germany, came in at 9.3% on a y/o/y basis in February, up from January’s 9.2% gain, driven by services and food costs. Inflation in France and Spain also jumped up in February to 7.2% and 6.1%, respectively. Germany’s central bank president Bundesbank President Joachim Nagel has said that the interest-rate step announced for March will not be the last with further significant rate steps possibly being necessary. This sentiment was echoed by Bank of Italy Governor Ignazio Visco who said, “there’s no question the tightening of the euro-area monetary stance must continue to ensure inflation doesn’t become more persistent.” Services inflation, which makes up most of core inflation, was revised upward to 4.4% from 4.2% in February. As service inflation is primarily due to wage growth this may signify an unanchoring of inflation expectations which could lead to more persistent, stickier inflation. 

Confusion for Britain? UK Prime Minister Rishi Sunak’s Brexit deal with the EU on Northern Ireland, although still requiring parliamentary approval, has buoyed sterling and the currency is likely set for further gains if the agreement receives parliamentary backing. However, the benefits may not be realised as the Bank of England may err on the side of caution and not raise rates as much or as continuously as investors may be expecting. On 1 March BoE Governor Andrew Bailey said nothing had been decided in terms of whether interest rates would need to rise again. In a cost of living conference speech he said, “At this stage, I would caution against suggesting either that we are done with increasing the bank rate, or that we will inevitably need to do more.” This follows his statement to the Treasury Committee in February that he was very uncertain about price-setting and wage-setting in the UK as the Bank had the largest upside skew in its forecasts that they have ever had on inflation. Earlier in February BoE Chief economist Huw Pill warned of raising rates too high due to the lags in the transmission of monetary policy and that there were quite a lot of the effects of those raises in interest rates still to come through. According to the Financial Times, markets anticipate UK rates will hit 4.75 per cent by the end of the year, up from an expectation of a peak of 4.25 per cent at the start of February.

Binance bumbling? According to the Financial Times, investors have pulled more than $6bn out of a Binance-branded digital token in the past month, in a sign that a recent US regulatory crackdown on digital assets is putting pressure on the world’s largest crypto exchange. This comes after the New York Department of Financial Services put pressure on Paxos, the stablecoin company behind issuance of the BUSD token, to shut down further issuance of BUSD. Coindesk.com reported that in a tweet on 27 February crypto exchange Coinbase said it will suspend trading of Binance USD (BUSD) starting 13 March because the stablecoin doesn’t meet its listing standards. Binance CEO Changpeng Zhao has said BUSD was never “big business” for the exchange, adding that Binance intended to support as many other stablecoins as possible. Nevertheless, according to data from CryptoCompare, BUSD represented approximately a fifth of Binance’s trading volume in the last year, climbing to as much as 40% last December. Meanwhile, Binance denied on 27 February that its decision to transfer $1.8 billion of stablecoin collateral to hedge funds such as Tron, Amber Group and Alameda Research between August and December 2022 had any impact on user holdings. An article by Forbes suggested that the funds moved by Binance were meant to back its B-peg USDC stablecoins. As noted by Cryptoslate.com, Forbes referred to these assets as “digital replicas” of Circle’s USD Coin — or assets tied to the value of USDC so that they can be circulated on Binance’s own blockchain. If Forbes’ accusations are correct, users may have been left with undercollateralized stablecoins. Binance co-founder and CEO Changpeng “CZ'' Zhao responded to the accusations on Twitter by saying that Forbes did not understand the basics of how an exchange works and that users deposits are traceable on the blockchain.

Key events in March

2 Mar 2023 G20 Foreign Ministers’ meeting
G20 foreign ministers will meet in New Delhi (India) for the first time under the new Indian presidency. The events in Ukraine will likely be a focus for discussions.

5 March 2023 National People’s Congress, China
Xi Jinping will be re-elected for a third term as president at the annual National People’s Congress session. In addition, a new premier will be appointed in March to replace Premier Li Keqiang. 

16 March 2023 ECB meeting and monetary policy decision. ECB President Christine Lagarde and other policy members such as Isabel Schnabel, have made clear that they expect to have a series of 50 basis-point rate hikes. High core inflation, rising wages and a tight labour market are pointing to the ECB monetary tightening cycle not reaching its peak rate until Q3 with markets pricing in a terminal rate of 4%. It currently stands at 2.5% but will almost certainly rise to 3% during the March meeting.

21-22 March 2023 US Federal Reserve Monetary Policy meeting. The unanimous vote in February to slow the rate path to a 25 basis points rise, to 4.75%, initially made investors think that the Fed may continue at that pace for the March meeting or even pause. However, with a still tight labour market, rising wages, and core inflation continuing to grow, the Fed is feeling the pressure to continue to raise rates, possibly to a higher terminal rate than they had previously expected in February. The federal funds rate is currently set in a range from 4.5% to 4.75%.

22-24 Mar 2023 UN Water Conference
The UN Water Conference will focus on the linkages between water, health, sustainable development, climate resilience, and environmental cooperation. It is the first meeting on water security specifically since 1977.

23 March 2023 Bank of England meeting and monetary policy decision. With inflation still running at 10.1% in January, the expectation was that the BoE would continue to raise rates by 25 basis points in the March meeting. This would represent a slowdown in the pace of tightening by the BoE following last month’s 50 bps rise. However, the statements by BoE Governor Andrew Bailey that nothing was certain has caused traders to trim bets on the likelihood of a 25 bps rise. According to Refinitiv, they now see a 10% chance that the BoE will keep rates on hold.

This article is provided to you for informational purposes only and should not be regarded as an offer or solicitation of an offer to buy or sell any investments or related services that may be referenced here.

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