Weekly Insights: Higher-for-Longer U.S. Interest Rates

U.S. equities saw their third consecutive week of losses, influenced by concerns over Middle East tensions and enduring high U.S. interest rates. Mega-cap technology shares were hit by rising rates, leading to a higher theoretical discount on future earnings. Additionally, the technology sector was impacted by a first-quarter revenue miss from ASML Holdings, reducing optimism regarding AI-related earnings. Despite this, the pullback so far has been contained, with the S&P 500 down about 5.5% from its recent high, following a 25% rally over the past 6 months. The U.S. economy, however, remains robust, supported by strong consumer demand and a healthy labour market, while global economic growth is stabilising.

Robust economic data seemed to increase concerns that the Federal Reserve would delay any interest rate cuts until September, if not until 2025. The Commerce Department reported that retail sales rose 0.7% in March, well above consensus expectations of around 0.3%, while February’s gain was revised upward to 0.9%. Fed Chair Jerome Powell stated at an economic conference that “recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.” The retail sales data helped push the yield on the benchmark 10-year U.S. Treasury note to its highest intraday level since early November.

In Europe, Central Bank President Christine Lagarde expressed optimism about the region’s economy, suggesting that it is nearing the end of a period of stagnation that lasted over a year. Lagarde highlighted signs of recovery in the output of the 20-nation eurozone, noting particularly strong performance in the employment and job market. Numerous ECB policymakers at the IMF meeting reiterated that June was the likely target date for lowering borrowing costs, barring unexpected economic shocks.

The UK’s unemployment rate unexpectedly rose to 4.2%, compared to the revised 4.0% from the previous month. Meanwhile, UK inflation remained higher than anticipated at 3.2%, showing a slight decrease from the previous reading of 3.4%. Bank of England Governor Andrew Bailey suggested that the UK might consider lowering interest rates before the US, highlighting differing inflation dynamics between the two economies. Bailey noted more “demand-led inflation pressure” in the US compared to the UK, following concerns over strong price data in America the previous week.

Chinese economic indicators presented a mixed picture in March and the first quarter of 2024. While industrial production grew by 4.5% year-on-year, below market expectations, the house price index dropped by 2.2%, and retail sales saw a modest increase of 3.1%, falling short of projections. However, gross domestic product (GDP) expanded by 5.3% year-on-year in the first quarter, surpassing market expectations slightly, despite a slight slowdown from the previous quarter’s growth rate.

The International Monetary Fund (IMF) has made a cautious adjustment to its projections for this year, revising upwards to 3.2% citing the resilience of the US economy and positive developments in emerging markets. Despite this optimistic outlook, lingering worries persist regarding persistent inflationary pressures and geopolitical tensions, serving as a reminder of the delicate balance in the current economic landscape.

Global stocks closed lower after a volatile week as investors turned risk-averse. U.S. stocks faced challenges, with the Nasdaq (-5.52%) and S&P 500 (-3.05%) seeing significant declines, while the Dow Jones (+0.01%) managed to stay flat. European shares (Euro Stoxx 50) fell by -0.75%, and the FTSE 100 dropped by -1.25%. China’s Shanghai Composite experienced a -2.94% drop, and the Nikkei 225 fell by -6.21%. The standout performer was the China Shanghai Composite Index, which ended the week up +1.52%. Brent oil prices declined by -3.36%, while the gold price, known for its safe-haven status, increased by +2.07%.

Market Moves of the Week:

Following a two-month upswing, South African headline inflation softened to 5.3% in March from 5.6% in February. The rate has held its ground between 5% and 6% since September 2023. At the same time, retail sales fell by 3.2% (month-on-month) in February, compared to an increase of 1.2% recorded in the prior month.

Finance Minister Enoch Godongwana revealed plans to manage the country’s debt burden by utilising future drawdowns from the Gold and Foreign Exchange Contingency Reserve Account. However, he ruled out using these funds for Eskom or Transnet, emphasising the need for fiscal consolidation through potential tax adjustments and expenditure cuts in the upcoming budget.

Meanwhile, Governor Lesethsha Kganyago of the South African Reserve Bank indicated that a new inflation target framework might not be finalised before the 29th of May election. On the energy front, Eskom announced a temporary halt to rotational power cuts, marking the longest respite since June 2022, and planned to restore a significant portion of generation capacity by the end of the week.

The JSE (-2.59%) tracked global peers lower this week after a significant selloff across all sectors, including the Resources (-4.21%), Industrials (-2.10%), and Financials (-2.13%) indices, all under pressure. The rand weakened throughout the week, closing at R19.10/$.

Chart of the Week:

In the 1990s, the “Fed Model” gained popularity, correlating bond yields with stock earnings yields. However, its use has declined over the past two decades, coinciding with a period where this correlation broke down due to record low interest rates and central banks’ implementation of quantitative easing measures post the Global Financial Crisis. Recent trends indicate a return to the historical norm, with long Treasuries yielding more than stocks. This was once considered necessary to compensate for bonds’ limited growth potential. While not inherently alarming, this shift complicates asset allocation for a generation accustomed to stocks outperforming bonds.

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Weekly Insights: Elevated US CPI and Escalating Debt Levels in China

U.S. stock markets saw a decline for the week due to increased concerns about conflict in the Middle East and ongoing inflation worries, leading to higher long-term Treasury yields. Growth stocks performed better than value shares, with interest rate-sensitive sectors like real estate investment trusts (REITs), regional banks, housing, and utilities weighing down on value stocks.

Investors reacted to three consecutive hotter-than-expected CPI readings by revising their expectations for rate cuts by the US Federal Reserve downward. Initially, they anticipated two to three rate cuts before year-end, with the first expected in July. However, following the 0.4% month-on-month increase in both headline and core March CPI, the market is now pricing in only one to two cuts, with the first not fully priced in until September.

Following the CPI data, US 10-year Treasury note yields spiked over 20 basis points and remain elevated at 4.53%. Despite this, Fed officials emphasised that the central bank is not rushing to adjust policy and prefers to wait for more data. The next crucial inflation data point is core PCE on 26 April.

Geopolitical tensions are on the rise as the USA warns of an imminent attack on Israel by Iran or its proxies. In response, the US Embassy in Jerusalem has issued a security alert and imposed travel restrictions on US government employees and their families within Israel, restricting travel beyond their respective cities. The USA vows unwavering support for Tel Aviv’s defence in the face of these threats.

All major U.S. equity markets ended the week lower. The Dow Jones Industrial Average down 2.37%, followed by the S&P 500 down 1.56%. The tech heavy NASDAQ composite faired best, still in negative territory, down 0.45%.

In February, UK GDP growth increased by 0.1% month-on-month, aligning with consensus expectations. January’s growth rate was also revised upward to 0.3%. Goldman Sachs forecasts Q1 GDP growth at 0.4%, with an annual growth projection for 2024 at 0.6%, surpassing consensus estimates of 0.3% and the Bank of England’s forecast of 0.2%. In other news, former Federal Reserve Chair Ben Bernanke conducted a review of the Bank of England’s economic model, identifying significant shortcomings such as outdated software and makeshift solutions that hindered the bank’s ability to generate alternative scenarios quickly. The BOE’s failure, along with other central banks, to predict inflationary pressures from pandemic-era economic disruptions and the Ukraine conflict prompted the review.

At its meeting on Thursday, the European Central Bank (ECB) maintained its interest rates unchanged. However, ECB President Christine Lagarde acknowledged that some members of the Governing Council were ready to reduce interest rates at this week’s meeting, although a majority preferred to wait until June for more data. Lagarde emphasised that the decision to lower rates is not contingent on actions taken by the Federal Reserve. European natural gas futures surged on Thursday to their highest level in over two weeks following renewed attacks by Russia on Ukrainian energy facilities. Benchmark futures spiked by as much as 7.1%, reversing the losses from the previous two days.

The FTSE 100 closed the week in positive territory, up 1.07% while the Euro Stoxx 50 closed the week lower, down 1.19%.

Japan’s stock markets saw gains throughout the week, with the Nikkei 225 Index rising by 1.36% and the broader TOPIX climbing 2.1%. Investors closely monitored the Japanese yen, which remained near a 34-year low, anticipating potential interventions by the country’s authorities to bolster the currency. In March, Japan’s domestic Corporate Goods Price Index (CGPI) saw a slight increase of +0.2% month-on-month. Year-on-year, the index also rose gradually by +0.8%.

China’s headline Consumer Price Index (CPI) inflation decreased, while Producer Price Index (PPI) deflation widened slightly in year-over-year terms. The decline in headline CPI inflation was driven by moderation in food prices and tourism-related services prices, likely due to reduced demand after the Lunar New Year. The widening of PPI deflation was primarily attributed to weak upstream sector prices. With soft Q2 inflation data, full-year 2024 forecasts for headline PPI inflation have been revised down to -1.1% year-on-year (previously -0.3% year-on-year), while the headline CPI inflation forecast remains at 0.4%, below consensus. China’s March trade growth surprised to the downside, the trade surplus in March was $58.6bn below consensus. Chinese stocks experienced a retreat, as weak inflation data highlighted the subdued demand prevailing in China’s economy. The Shanghai Composite closed the week lower down -1.62%, while Hong Kong’s Hang Seng Composite ended marginally higher, up 0.11%.

Market Moves of the Week:

In local political news, the Social Research Foundation’s latest poll indicates a significant shift in support, with Jacob Zuma’s MK party gaining up to 13% of the vote while the ANC’s support slips to just 37%. Analysts suggest that such an outcome could compel the ANC to form a coalition with a larger party to maintain control of the country’s economy, potentially leading to policy concessions and changes in appointments. There’s also speculation that a poor election performance could prompt the ruling party to remove President Cyril Ramaphosa from office before the end of his term, causing concern among investors. The Independent Electoral Commission (IEC) has taken steps to challenge Jacob Zuma’s candidacy in the elections, potentially sparking public unrest if a negative ruling ensues.

These political developments have led to volatility in the currency and bond market, with the South African Rand depreciating by 1.02% against the US Dollar, closing the week at R18.86/$. The SA 10-year bond yields spiked 0.49% this week, a major move, pushing yields up to 11.02%. Investors are grappling with the implications of these events for local assets prices and forward-looking economic policy.

In share specific news, Transaction Capital (TCP) recently unbundled and listed their used-car business, We Buy Cars Holdings Ltd (WBC), on the JSE on 11 April 2024. WBC, the first new listing on the JSE for the year, debuted at R20 per share, surpassing its initial public offering price of R18.75 per share. This resulted in a total market capitalisation of R8.34 billion ($444 million) at the opening. The JSE anticipates approximately ten listings in 2024, including companies like cannabis firm Cilo Cybin Holdings and the highly anticipated Coca-Cola Beverages Africa. These listings could provide a much-needed boost to the JSE, which has faced challenges in attracting listings in recent years.

On the local equity front, the Resource sector caught a major bid pushing the JSE ALSI into positive territory for the week, up 0.72%. Resources ended the week up 9.75%. Both Industrials and Financials were lower, down 2.04% and 3.21% respectively. The SA Listed Property sector also ended the week down 1.70%.

Chart of the Week:

The International Monetary Fund notes a steady increase in China’s public debt-to-GDP ratio over the last decade. Projections anticipate a further rise as China aims to stimulate the economy amid a slowdown driven by the real estate sector. This growing debt has sparked concerns among rating agencies, with Fitch Ratings revising China’s outlook from stable to negative. Source: International Monetary Fund & Bloomberg.

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Weekly Insights: Strong Hiring and Manufacturing Growth in March

In March, U.S. employers surpassed expectations by hiring a significantly larger number of workers and increased wages. This suggests that the economy concluded the first quarter on a robust note and could potentially postpone anticipated interest rate cuts from the Federal Reserve this year. According to the Labor Department’s Bureau of Labor Statistics, nonfarm payrolls surged by 303,000 for the month, exceeding the downwardly revised 270,000 gain observed in February. Average hourly earnings rose 0.3% in March after gaining 0.2% in the prior month.

U.S. manufacturing exhibited growth for the first time in 18 months in March, with a notable resurgence in production and an uptick in new orders. According to the Institute for Supply Management (ISM), the manufacturing index rose to 50.3 in March from 48.3 in February. Conversely, growth in the U.S. services industry continued to decelerate. The ISM reported on Wednesday, that its non-manufacturing Purchasing Managers’ Index (PMI) fell to 51.4 last month from 52.6 in February. This marks the second consecutive monthly decline in the index following a rebound in January.

Annual headline inflation in the eurozone decelerated beyond initial forecasts, reaching 2.4% in March compared to 2.6% in February. Similarly, core inflation, excluding volatile food and energy components, eased to 2.9% from 3.1%. However, service prices saw a sustained year-over-year increase of 4.0% for the fifth consecutive month.

Concurrently, the eurozone witnessed a notable shift as the composite Purchasing Managers’ Index (PMI) returned to positive territory in March for the first time since May. S&P Global revised its estimate for the eurozone’s composite PMI, incorporating both services and manufacturing, to 50.3, marking an increase from the initial 49.9. A reading above 50 indicates an expansion in private-sector business activity.

Minutes from the European Central Bank’s (ECB’s) March meeting revealed policymakers’ growing confidence in the timely deceleration of inflation towards target levels. While a majority acknowledged the strengthening case for rate reductions, they also emphasized the importance of awaiting key economic data scheduled to be released after the ECB’s April meeting before making any decisions.

China’s manufacturing sector experienced its most rapid expansion in 13 months, as indicated by a private survey. This growth was accompanied by a notable surge in business confidence, reaching an 11-month peak, propelled by an uptick in new orders from both domestic and international customers. The Caixin/S&P Global Manufacturing Purchasing Managers’ Index (PMI) increased to 51.1 in March from 50.9 the previous month, reflecting this positive trend.

This week, global equity markets experienced a pullback from their recent highs, amid hawkish comments from some U.S. Federal Reserve policymakers and elevated crude oil prices, which raised concerns about the timing of potential interest rate cuts. In the U.S., major indices such as the Dow Jones (-2.27%), S&P 500 (-0.95%), and Nasdaq (-0.80%) all ended the week lower. Similarly, the pan-European STOXX 50 Index saw a decline of -1.35% during the shortened trading week, breaking a 10-week streak of gains. The UK’s FTSE 100 Index also saw a modest decline of -0.52%.

Japan’s stock markets also faced downward pressure, with the Nikkei 225 Index declining by -3.41% over the week.

In contrast, Chinese equities showed resilience, supported by positive economic indicators suggesting a potential acceleration in economic growth. The Shanghai Composite Index rose by +0.92%, while in Hong Kong, the benchmark Hang Seng Index increased by +0.98%.

Market Moves of the Week:

South African manufacturing activity declined in March, as indicated by Absa’s latest Purchasing Managers’ Index (PMI) survey released on Tuesday. The seasonally-adjusted PMI decreased to 49.2 points in March from 51.7 in February, falling below the critical 50-point threshold that distinguishes expansion from contraction. According to Absa’s statement on Tuesday, despite significant improvements in February, both the business activity and new sales orders indices decreased in March, though they remained above the recent lows observed in January.

On Tuesday, the South African Revenue Service (SARS) announced its preliminary estimates, revealing that it had collected over R1.74 trillion during the 2023/24 fiscal year. This represents a 3.2% increase compared to the previous year’s collection. Moreover, the figure exceeds the forecast outlined in Finance Minister Enoch Godongwana’s February budget presentation to Parliament by R10 billion. Consequently, this surplus indicates a potential for a slight reduction in the Treasury’s projected budget deficit of 4.9% of gross domestic product (GDP).

During the week, the JSE All-Share Index saw a modest increase of +0.32%, largely driven by a notable surge of +5.15% in the resources sector. In contrast, the property sector (-1.66%), industrial sector (-0.98%), and the financial sector (-0.85%) ended the week with losses. By the close of trading on Friday, the rand strengthened against the U.S. Dollar, trading at R18.67, marking a weekly appreciation of +1.11%.

Chart of the Week:

After extensive debate, the anticipated scenario of “higher for longer” has materialized. The fed funds rate reached 5% in March last year, with market expectations pricing it to remain at this level until November. While previously perceived as a concerning scenario, such elevated rates typically indicate a robust economic environment. Source: Bloomberg.

As always, we appreciate your support and value your trust in LNKD Investment Managers.