Muzinich Weekly Market Comment:

August 19, 2024

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In our latest roundup of developments in financial markets and economies, we look back at a much calmer week of price action following a turbulent start to the month.

Order was restored to financial markets last week. Most major equity markets continued their recovery after the sharp sell-off at the start of the month, while our preferred measure of volatility, the VIX, was back below 16, having hit 38.6 on August 5.^[1]

Government bonds fulfilled their familiar role of safe havens during the turbulence of the first week of August, but yields were relatively flat last week, perhaps signalling that a drastic policy response by central banks may not be necessary. Meanwhile, in corporate credit, all sub-asset classes continued to eek out positive returns, with the US a marginal outperformer over Europe and Emerging Markets for both investment grade and high yield.

Final piece of the puzzle?

After a series of underwhelming economic data releases and evidence that inflation is falling back towards the 2% target, the US Federal Reserve is expected to announce a long-awaited cut to policy rates at the September meeting of the Federal Open Market Committee (FOMC).

The Fed has always maintained it will be led by data; any lingering doubts about a September cut should have dissipated with last week’s Consumer Price Index (CPI) and Producer Price Index (PPI) numbers.

Core PPI (excluding food and energy) was flat in July month-on-month versus expectations of a 0.2% increase,^[2] while the core goods components of CPI have been negative for 7 consecutive months year-on-year.^[3] As a result, Goldman Sachs lowered its core Personal Consumption Expenditures (PCE) estimate for July to 0.14% month-on-month (down from 0.17%).^[4]

PCE is a key metric for the Fed; the next PCE release on August 30 could be the final piece of the data puzzle needed for the Fed to finally begin its next monetary easing cycle (See Chart of the week).

The big question is whether it opts for a 25 or 50 basis points (bps) cut in September. This week’s Jackson Hole Economic Policy Symposium should reveal much about the Fed’s thinking, with its Chair Jerome Powell due to give a keynote address on August 23. As of now, the overnight interest rate swap market seems undecided on 25bps or 50bps and is instead pricing in a 35bps cut.

Bad news (for) bears

Meanwhile, after the market’s bearish reaction to July non-farm payroll (NFP) numbers and gloomy projections over consumer spending, the latest retail sales and unemployment claims numbers indicate that the US labour market and consumers may not be as frail as some feared.

Advance estimates of US retail and food services sales in July were up 1% month-on-month and 2.7% year-on-year.^[5] Meanwhile, initial jobless claims for the week ending August 10 were 227,000, down 7,000 from the previous week and below the 235,000 forecasted.^[6]

It may be that the July NFP report was a seasonal blip. Assuming good weather for the rest of the month, the NFP release on September 6 could show an upside surprise as workers return from weather-related events and after the modest increase in employment reported in July.

Big miss in Europe

Economic data in Europe has generally disappointed recently. That trend continued last week, with industrial production the most notable number. Year-on-year industrial production for the Eurozone in June was -3.9%, a big miss on market expectations of -2.9%.^[7] This sign of weakness was compounded by a downward revision of the May figure from -2.9% to -3.3%.

With inflation heading back towards the European Central Bank’s 2% target, investor focus, as in the US, is shifting from inflation to growth, with data points such as industrial output prompting calls for a quicker and more significant response from the central bank.

Fifth time lucky?

The big news from Japan this week was the decision on August 14 by Prime Minister and President of the Liberal Democratic Party (LDP), Fumio Kishida, to step down.^[8] This follows a funding scandal within his party and public discontent at the rising cost of living. 

The LDP will hold a leadership contest next month to replace Kishida. So far, only one candidate has declared their intention to run far – former defence minister Shigeru Ishiba, in what will be his fifth attempt to lead the party. Other potential contenders include those who ran against Kishida in 2021, such as Taro Kono, current Minister for Digital Transformation, and Sanae Takaichi, Minister of State for Economic Security. 

However, with the next general election set for October 2025 and given dwindling support for the current administration, it is possible newer talent could break through. Among the names being touted are Shinjiro Koizumi, son of former Prime Minister and Elvis Presley superfan Junichiro Koizumi, and Yōko Kamikawa, current Minister for Foreign Affairs.

Despite the uncertainty generated by the leadership contest, it is expected that whoever wins will continue Kishida’s policy approach. The market brushed off news of Kishida’s departure — the benchmark Nikkei 225 equity index was up 0.8% the day after the announcement and was almost 9% higher over the week.

If anything, the market is more focused on what the Bank of Japan does next, following its surprise July 31 interest-rate hike that was a major contributor global market volatility at the start of the month, as we covered in our last Weekly Market Comment.

China crisis?

If media reports are to be believed, the latest economic data to come out of China last week signified an extension of its “economic malaise”.^[9] However, in our view, it is difficult to see how the data revealed anything we didn’t know or anything out of step with consensus. While Q2 GDP growth of 4.7% year-on-year was slightly below the official target of “around 5%”, first-half growth was right on the number.

What also shouldn’t be forgotten is the measures announced by the government this year to support the economy. That theme was reinforced on Thursday by Bank of China Governor, Pan Gongsheng. In an interview with China Central Television, he confirmed the central bank’s supportive monetary policy will continue and said further steps “will be made in accordance with the requirements of the State Council”.^[10]

The government is undertaking a multi-year shift in the economy, away from the moribund property sector and towards advanced manufacturing and higher consumption. In our view, this period will not be without friction and adjustments will likely be needed along the way. Ultimately, however, the economic shift is critical for China’s long-term prosperity and investors would be well-served not to obsess over one-off data releases.

Elsewhere in Asia, Srettha Thavisin on August 14 became the fourth Thai prime minister in the past 16 years to be removed from office by the Constitutional Court. This followed widespread outrage at his appointment of a convicted criminal to his cabinet.^[11] Thavsin had been in power less than a year.

Political upheaval is nothing new in the Southeast Asian country, but this latest episode of uncertainty is likely to provide yet another headwind. Thailand’s economy is already lagging other countries in the region, while the benchmark SET stock market is down 9.5% year-to-date, making it one of the worst performers in Asia.

Chart of the week: US inflation moves closer to target

Source: US Bureau of Economic Analysis, ‘Personal Consumption Expenditures Price Index,’ as of July 26, 2024. For illustrative purposes only.

Past performance is not a reliable indicator of current or future results.

References

[1] Cboe Global Markets, as of August 16, 2024
[2] US Bureau of Labor Statistics, ‘Producer Price Index News Release summary,’ August 13, 2024
[3] US Bureau of Labor Statistics, ‘Consumer Price Index Summary,’ August 14, 2024.
[4] Goldman Sachs, ‘Core US inflation is on track to fall further in 2024,’ August 15, 2024
[5] United States Census Bureau, ‘Advance Monthly Sales for Retail and Food Services,’ August 15, 2024
[6] US Department of Labor, ‘Unemployment insurance weekly claims,’ August 15, 2024. 
[7] Eurostat, as of August 14, 2024
[8] Reuters, ‘Japan's Prime Minister Kishida to resign, paving way for new leader,’ August 14, 2024
[9] Bloomberg, ‘China’s Economy Fails to Pick Up After Worst Stretch in Five Quarters,’ August 15, 2024
[10] Bloomberg, ‘China Central Bank Sees More Growth Steps But Nothing ‘Drastic,’ August 15, 2024
[11] Al Jazeera, ‘Thai court orders dismissal of Prime Minister Srettha Thavisin,’ August 14, 2024

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.  The opinions expressed by Muzinich & Co. are as of August 19, 2024, and may change without notice. All data figures are from Bloomberg, as of August 16, 2024, unless otherwise stated.

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