Market correction or August doldrums
Inflation has been the top theme of economic enthusiasm for the past several weeks, but in the last few days, it’s been supplanted by a market pull-back. There are several moving pieces here, and it’s easy to misread the underlying catalyst for this shift in sentiment at just a glance. So, let’s break it down and try to identify what’s going on.
The first and most obvious part is the pandemonium following the US pullout of Afghanistan and the general spike of risk aversion. This is a short-term cause of some risk aversion and may yet devolve into a humanitarian crisis, but the direct impact on markets has been minimal up to this point. Perhaps the largest impact of this crisis on markets has been to undermine President Biden’s push for a larger fiscal spend, which has been a driver of toppy US asset valuations.
Following this is a more nuanced story. The Chinese authorities are pushing for new regulation that seeks to redress some wealth inequity; this has propelled quite a few Chinese tech and gaming stocks lower, although the full scope of the regulatory change is not yet fully understood. More importantly, it’s causing some re-evaluation of the market perma-optimism over continued asset appreciation. This also leads us neatly to the revival of an old theme, monetary policy.
We’ve been commenting for some time that central bankers, starting with the Federal Reserve, are shifting towards a quantitative easing wind down, and we've argued that this was preferable to rate hikes because its impact on the underlying economy would be more muted. Elsewhere, the release of several softer economic data points has hinted that the global economy isn’t quite as hot as many analysts had expected. The upcoming Jackson Hole symposium of central bankers, which is to focus on 'Economic Policy in an Uneven Economy', might hit out directly at the distortionary wealth effects of QE and should worry asset perma-bulls.
Lastly, one of the key factors that have dented market optimism is the realization that Covid impacts on the supply-side of the economy are a very real cap to economic output and, consequently, valuations. Incidentally, this is one of three reasons (see last week’s update) why we concluded rate rises weren’t on the horizon.
Bottom Line: So, the biggest question on everyone’s mind is: does this signal a turning point in markets, or is it a blip on the road to a rebound? The answer is that we just don’t know yet, but we can certainly lay out some criteria to help us view this through the right lens:
1. August is a low volatility month where market-moving events have an amplified impact, and this might be part of the reason for a bearish turn on oil or pullback in commodity prices. A point against a market correction.
2. Wealth inequality is not a new topic, and it’s been getting more attention recently from the central banking community. Seeing Chinese authorities pick up on it, and drive change so speedily, is likely to spur greater action in the West, where monetary policy has been responsible for creating the market conditions where inequality is exacerbated. A point in favour of a market correction.
3. A single case of covid has shut down the entire country of New Zealand and, a single case has also shut down the world’s third-largest shipping port in China. This isn’t the end of these types of disruptions, and with vaccine efficacy levels reported to be lower than previously assumed, even a slow plod towards immunization hitting critical mass won’t shut the door on this risk permanently. A point in favour of a market correction.
The week ahead
Sterling faced some heavy selling pressure last week as Dollar-strength made a return. Cable closed the trading week down by around 1.9%, and GBP/EUR closed just over 1.0% softer. Coronavirus has been kept in check one month on from July’s full easing of lockdown restrictions, with around 88 million doses of the vaccine having now been given. The UK government is now thought to be gearing up for booster shots in September. The Bank of England was given a breather as year-over-year inflation nudged lower to 2.0% in July, with the fear of higher prices calming for now. The FTSE 100 is trading 0.4% higher this morning after falling 0.9% last week.
- The flash Manufacturing Purchasing Managers Index for August came in at 60.1 following July’s reading of 60.4. The flash Services PMI moved lower to 55.5 after reading at 59.6 previously.
- Confederation of British Industry Industrial Order Expectations climbed slightly higher this month to hit 18 versus last month’s 17.
- CBI Realised Sales to be released on Wednesday are projected to move lower to 19 after coming in at 23 previously.
The Eurozone has continued to maintain a record recovery pace from the Coronavirus pandemic, even with the bloc experiencing an initially sluggish start. PMI figures released so far this quarter have reached their highest average levels in almost 21 years, despite Delta variant fears creating a headwind for demand and sticky supply constraints. Consumer confidence is expected to fall slightly this month, mirroring most other advanced economies as data releases continue to miss forecasts. EUR/USD has advanced around 0.3% while the Stoxx 600 is up 40 basis points in early trading.
- German flash Manufacturing PMI came in at 62.7 today versus 65.9 last month, while the Services PMI also tracked lower to 61.5 after reading 61.8 in July.
- There’s a similar story throughout the Eurozone, as the flash Manufacturing PMI fell to 61.5 following 62.8 last month, while the Services PMI remained relatively unchanged at 59.7 versus 59.8 for July.
- Eurozone Consumer Confidence is due to be released today, forecast to print at -5 following a reading of -4 last month.
- The German ifo Business Climate will be released on Wednesday and looks set to read 100.2, lower than the July print of 100.8.
The US Dollar Index surged just over 1% last week, reaching a 9-month high as a blend of economic data misses and Delta variant fears knocked risk sentiment. The question of whether the Dollar can sustain this move could be answered this week, as Federal Reserve Chairman Jerome Powell is expected to speak at the Jackson Hole Symposium on Friday. Markets are eagerly awaiting more news on tapering, with some analysts predicting asset purchases to be reduced as early as this year. However, with supply chain constraints and the greater realisation of downside risks in the economy, this decision to scale back support could well be delayed.
- PMIs look likely to fall this month in the US, with Manufacturing forecast at 62.4 versus 63.4 last month, and Services projected to read 59.1 following a previous reading of 59.9.
- Preliminary GDP q/q is expected at 6.6% for Q2 2021 versus 6.5% in Q1.
- The Core Personal Consumption Expenditures Price Index m/m is anticipated to have contracted marginally at 0.3% in July after printing at 0.4% in June.
- The Jackson Hole Symposium will be the focal point of the week, set across Thursday and Friday, with Fed Chair Jerome Powell expected to speak.
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