Investors shifted their focus from inflation to the risk of recession this week, causing markets to rally. Weaker than expected global economic data and a broad selloff in commodity markets have caused the market to modestly lower central bank rate-hike expectations. A paper published this week by the Federal Reserve put the odds of a U.S. recession in the next 12 months at 50% and the probability of one over the next two years at 66%.
U.S. Federal Reserve Chair Jerome Powell testified before congress on Wednesday and Thursday that the Fed is not trying to incite a recession but that one is certainly possible as the central bank tightens policy to restrain rising inflation. He also stated that allowing inflation to become entrenched would be more painful for the economy than a recession.
Bad news for the economy was interpreted as good news for stocks this week. Investors reacted favourably to softer flash purchasing managers’ indices (PMI) for both the U.S. and eurozone, which showed that the pace of economic growth in developed economies slowed markedly in June, a good sign for possible inflation moderation. The Eurozone manufacturing PMI decelerated to a 22-month low, falling from 54.8 in May to 51.9 in June, while U.S. PMI fell to a 23-month low of 52.4 (PMI readings greater than 50 signal expansion). The services readings in both regions dropped to levels last seen during the Omicron wave five months ago.
U.S. home sales fell to their lowest level in May since June 2020, with the National Association of Realtors’ chief economist predicting further declines ahead in the face of higher mortgage rates. In other U.S. economic news, the University of Michigan’s final reading of June’s consumer sentiment was revised down to 50.0, its lowest level in records dating back over four decades.
On Friday, a deeply divided U.S. Supreme Court overturned the 1973 Roe v Wade decision and erased the constitutional right to abortion, issuing a historic ruling likely to render the procedure largely illegal in half the country. Just hours after the ruling, Republican-controlled states including Texas and Missouri moved to severely limit or ban the procedure while some two dozen other states are expected to do so. President Joe Biden warned that women’s rights and health are at risk under the GOP-appointed majority’s ruling and pledged he would protect access to early-pregnancy abortion drugs.
Germany warned that Russia’s moves to slash Europe’s natural gas supplies risks sparking a collapse in energy markets. The country is now moving toward rationing natural gas as Russia throttles back supplies delivered via pipelines. In other euro area news, European Union leaders on Thursday formally agreed to making Ukraine, along with Moldova, a candidate for membership in the bloc. Ukraine will likely have to undergo a lengthy reform process to be granted full membership.
Inflation continues to soar in the United Kingdom, with its consumer price index rising 9.1% year over year in May. The annualized figure hit the highest since March 1982 and is also the highest rate out of the Group of Seven (G7) countries.
As the rest of the world “moves past” Covid-19, China can’t seem to escape the virus. The country’s latest outbreak is now shifting to its south coast, away from key cities Beijing and Shanghai. However, the technology hub Shenzhen and gambling enclave Macau are now racing to stop outbreaks as cases rise. China’s covid zero policy continues to hamper growth in the region, with Beijing and Shanghai’s retail sales slumping 26% and 37% in May following harsh lockdowns.
U.S. stocks rallied this week with nearly every sector in the index recording strong gains. Energy stocks were the exception however, as oil continued to retreat from its recent highs over most of the week. Major U.S. indices’ ended the week higher with the S&P 500 Index rising out of bear market territory (+6.45%). The Nasdaq rose +7.49% and Dow Jones jumped +5.39%. Shares in Europe (Euro Stoxx 50) bounced +2.35% while the FTSE 100 rose by +2.74%. Chinese stocks gained, with the Shanghai Composite up 0.99 %. The Nikkei 225 ended the week up +2.04%. Brent oil dipped -0.37% while Gold fell -0.75%.
Market Moves of the Week
South Africa’s (SA) inflation rate hit a 5-year high in May, coming in at +6.5% yoy, breaching the South African Reserve Bank’s 6% ceiling. The spike in inflation topped April’s +5.9% and significantly surprised expectations of +6.1% yoy. The jump can be largely attributed to a rise in food (+6.3% yoy) and fuel (+32.5% yoy) inflation, driven by global rising prices. Core inflation (which excludes food, non-alcoholic beverages, petrol and energy) only increased from +3.9% yoy in April to +4.1% yoy in May.
Joe Phaahla, SA’s Health Minister, abolished the country’s remaining coronavirus-related restrictions on Wednesday. Phaahla suggested that due to a decline in reported Covid-19 cases and hospitalizations, the controls around the wearing of masks, curbs on gathering sizes and border checks for Covid-19 can be dropped.
Tensions are high at Eskom Holdings SOC Ltd. The state power utility has confirmed protests at a number of power plants following a breakdown in wage negotiations. Unprotected strikes have been reported at nine operations, increasing the probability of loadshedding being escalated in the coming days as backup power reserves are currently being used to meet demands.
The sixth and final report of the Zondo Commission’s State Capture Inquiry was handed to President Cyril Ramaphosa on Thursday. The National Prosecuting Authority have stated that now that the last section of the report has been published, they will be moving on with their criminal investigations of those suggested in the report.
The JSE (+1.46%) rebounded this week along with global peers, but was held back by Resources (-4.54%) as prices for various commodities eased. The rand strengthened over the week to end at R15.80/$.
Chart of the Week
As fixed-income yields have gone up, mangers have started to look at fixed-income a little bit more. The global bond selloff has pushed yields to attractive places relative to stocks. The S&P 500’s earnings yield is around 5.3% at the moment, just 55 basis points above the average US investment-grade (corporate debt) yield of 4.7%. That’s close to the narrowest gap since 2010.