Week in Review: U.S. Inflation Surprises to the Upside

U.S. inflation accelerated in June, ahead of expectations. Headline inflation rose 9.1% from a year earlier, the largest gain since 1981. This suggests the Federal Reserve has more work to do to achieve its price stability mandate. With the Federal Reserve likely to continue hiking interest rates to cool rampant U.S. inflation, the risk of the U.S. economy heading into recession has increased.

It is also worthwhile noting that although U.S. markets ended the week lower, June’s surprise inflation number elicited a contrasting response to May’s inflation surprise, with the S&P 500 strengthening post the announcement, indicating markets might already be looking past the inflation peak to the likelihood for slower economic growth ahead and easier monetary policy.

The bond market echoed this view with one of the U.S. bond market’s most widely watched indicators of potential recession risk reaching levels last seen in 2007. The so-called inversion of the yield curve - in which longer-term rates fall below those on shorter-dated maturities - is regarded as a potential leading indicator of an economic slowdown that could eventually result in rate cuts.

The U.S. housing market also saw a rise in the percentage of deals cancelled in June as rising mortgage rates made homes more expensive, pushing some buyers to walk away. Across the country, nearly 60,000 home sales fell through, according to Redfin. This equates to 15% of transactions that went into contract in June.

Mario Draghi offered his resignation as Italian Prime Minster this week, a move that was rejected by the President. Draghi will address parliament early next week, and that could be followed by a confidence vote.

The euro reached parity with the U.S. Dollar for the first time in two decades, after depreciating by over 12% against the greenback this year. The combination of the war in Ukraine and the resulting energy crisis which threatens to push the euro area into recession; and two central banks moving at vastly different speeds are some of the drivers behind the euro’s weakness. The European Commission lowered its economic forecasts. GDP expectations for 2022 remained unchanged at 2.7% but revised lower to 1.5% from 2.3% for 2023.

UK GDP expanded by 0.5% in May (month-on-month), compared with a fall of 0.3% in the previous month. Markets were anticipating GDP to ease 0.1%.

The Bank of Canada hiked rates by 100-basis points, to the central bank’s policy rate of 2.5%. The 100-basis point move is the largest increase since 1998. Markets and economists were anticipating a 75-basis point hike.

The Chinese economy grew at the slowest pace in more than two years, reflecting the impact of the nation's Covid Zero approach. Second-quarter GDP increased 0.4% from a year earlier, far weaker than the 1.2% consensus. The economy contracted 2.6% versus the previous quarter. Chinese property prices also fell for a 10th month in June. New home prices in 70 cities slipped 0.1% from May. Authorities are making 7.2 trillion yuan ($1.1 trillion) in funds available for infrastructure spending, a decisive shift away from a focus on controlling debt toward supporting a lockdown-impacted economy.

Speaking at a media conference, Gary Gensler, Chair of the U.S. Securities and Exchange Commission (SEC) said on Wednesday that there is doubt on the possibility of a deal being reached with China on access to Chinese companies’ audit reports. “I’m not particularly confident - it’s really up to our counterparties,” adding that “good-faith” negotiations continue “but there is a risk here.” U.S. and Chinese officials have been negotiating for more than two years to ensure access to the audit papers of Chinese companies traded in the U.S. via American Depositary Receipt (ADR) structures.

Corn and wheat futures fell the most in over a year in Chicago after a U.S. report saw bigger-than-expected world grain reserves. The U.S. Department of Agriculture raised its global wheat stockpiles estimate on Tuesday, bucking analyst expectations for a decline. Corn inventories were also up. The figures are of particular importance because of food inflation that’s swept across the globe this year, and more abundant reserves is a sign of possible relief. World food prices last month dropped from a near record.

Russia closed the Nord Stream 1 gas pipeline supplying Germany for scheduled maintenance work until the following Friday. The German government is concerned that Russia may not fully reopen it on that date in retaliation against European sanctions, which could force Germany to impose rationing on industries and households to preserve winter stockpiles.

India is expected to surpass China to become the world’s most-populous nation in 2023, four years ahead of an earlier estimate by the United Nations. The UN expects global population to hit 8 billion in November. More than half the projected rise between now and 2050 is expected to be in just eight countries: Congo, Egypt, Ethiopia, India, Nigeria, Pakistan, the Philippines, and Tanzania, according to a report titled World Population Prospects 2022. China is expected to experience an absolute decline in its population as early as next year.

Global equities were softer this week. In the U.S., the Dow Jones (-0.16%), S&P 500 (-0.93%) and Nasdaq (-1.57%) were all negative. Similarly, the Euro Stoxx 50 (-0.84%), FTSE 100 (-0.52%) and Shanghai Composite Index (-3.81%) were all weaker. The exception was the Nikkei 225 Index (+1.02%) ending the week stronger.

Market Moves of the Week

Police have apprehended two former employees of Swiss industrial firm ABB Ltd. and their wives for corruption linked to more than half a billion rand of contracts with Eskom. At the same time, S&P Global Ratings believes that Eskom may need to borrow an extra 45 billion rand to purchase diesel and pay inflation-beating salaries to workers. A Daily Maverick article also highlighted that Koeberg has lost between 250 – 300 skilled professionals in the last year. The latest to leave was the 27-year veteran Riedewaan Bakardien, who was the Chief Nuclear Officer who is moving to a Canadian nuclear power plant.

South Africa’s labour minister said he’ll oppose any move to privatize Eskom as it struggles to generate power, avoid outages, and repay $23 billion of debt. According to the minister, privatizing the power utility will be detrimental to the poor and employment. In a contrasting view, S&P Global Ratings said privatization may be the best option to resolve the power crisis in Africa’s most-industrialised nation.

Short-term insurers have seen a significant increase in claims because of the severe power cuts across SA. According to Dialdirect Insurance, burglaries increased by 3.2% and vehicle accidents by 5.2% when there is no electricity. This is based on data analysed from July 2019 to May 2022.

The National Union of Metalworkers of SA (Numsa), the country’s largest trade union with more than 400,000 members, said on Wednesday that it is demanding wage increases of up to 20% in the multibillion-rand automotive industry.

SA mining production decreased by 7.8% (year-on-year) in May, compared to market expectations of a 10.9% increase.

The JSE All-Share Index ended the week down -4.74%, with all three of the major sectors including resource (-11.30%), industrial (-3.11%) and financial (-1.32%) shares weaker. By Friday close, the rand was trading at R17.07 to the U.S. Dollar, continuing to be impacted by a strong U.S. Dollar.

Chart of the Week

U.S. Treasury two-year yields, sensitive to imminent Federal Reserve moves, climbed further this week. The inversion between two-year and 10-year yields – a potential recession indicator – is the deepest since 2000. Source: Bloomberg

Investor anxiety has been heightened recently by the war in Ukraine and impending rate rises by the Federal Reserve. As such, we advise investors to maintain a calm stance during the crisis, diversify, and maintain exposure to long-term themes. Investors need to look beyond near-term news and gain exposure to industries benefiting from longer-term growth trends.

The information included above as well as individual companies and/or securities mentioned should not be construed as investment advice, a recommendation to buy or sell or an indication of trading intent on behalf of any Strategiq product. Strategiq Capital is an authorised financial services provider (FSP 46624).