Global Markets Weekly Update

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Bad news for the economy interpreted as good news for stocks

Signs that inflation might be moderating as growth cooled helped stocks rally sharply over the holiday-shortened week, lifting the S&P 500 Index out of bear market territory. Nearly every sector in the index recorded strong gains. Energy stocks were the notable exception, as oil continued to back off from its recent highs over most of the week. T. Rowe Price traders noted that month- and quarter-end flows may have increased trading volumes, as did the rebalancing of Russell indexes following the close of trading Friday. Markets were closed on Monday in their first observance of Juneteenth.

The week’s economic data offered several signals that the Federal Reserve’s forceful turn toward monetary tightening was having the intended effect of slowing the economy and moderating inflation. On Tuesday, the National Association of Realtors reported that existing home sales fell to their lowest level in May since June 2020, and its chief economist predicted further declines ahead in the face of higher mortgage rates. The Chicago Federal Reserve also reported that its gauge of national economic activity had reached an eight-month low. On Thursday, S&P Global’s index of June manufacturing activity came in well below forecasts (52.4 versus roughly 56), while its services gauge also missed estimates and hit its lowest level since January.

Manufacturers raise prices at lowest rate in 14 months

Investors appeared to react favorably to the S&P Global data, in part because it showed that manufacturing input inflation, although still elevated, fell to its lowest level in five months, while output charge inflation (the prices companies charge) had reached its lowest level since March 2021. “Although firms continued to pass through hikes in costs to clients, some mentioned concessions were made to customers,” the report noted.

The week’s biggest gains came Friday, following signs that consumers were stabilizing their inflation expectations as confidence in their finances reached new lows. The University of Michigan’s final reading of June consumer sentiment was revised down to 50.0, its lowest level in records dating back over four decades. The report also showed that consumers expect inflation to rise at an annualized rate of 5.3% for the second month in a row, below forecasts and the peak rate of 5.4% recorded in March and April. Consumers’ five-year inflation expectations rose slightly to 3.1%, but this was somewhat below consensus expectations and in line with January’s reading. Since August, expectations have remained within a range of 2.9% to 3.1%.

Longer-term yields fall back

Indeed, Fed Chair Jerome Powell testified before Congress on Wednesday and Thursday that inflation expectations appeared to remain anchored, which seemed to play a role in boosting sentiment in both equity and fixed income markets. Despite hawkish comments from some other current and former Fed officials, futures markets began pricing a slightly higher chance of only a 50-basis-point (bp, or 0.50 percentage point) increase in the federal funds target rate at the next policy meeting—although another 75 bp increase still seemed the most likely. Powell’s comments, along with the weaker-than-expected economic readings, also briefly pushed the yield on the benchmark 10-year Treasury note near 3.0%, down significantly from the previous week’s intraday peak of nearly 3.5%. (Bond prices and yields move in opposite directions.)

The broad municipal bond market generated solid gains through most of the week, aided by the pullback in Treasury yields. T. Rowe Price municipal bond traders reported that favorable supply conditions—marked by manageable issuance levels and light dealer inventories—mitigated technical headwinds from continued fund outflows industrywide.

According to our traders, a relatively quiet primary calendar supported investment-grade corporate bonds from a technical perspective. However, Powell's acknowledgment to lawmakers that the tightening cycle may induce a recession and the below-consensus manufacturing data weighed on market sentiment. After tightening at the beginning of the week, corporate credit spreads widened alongside the less supportive macro backdrop.

In the high yield market, higher-quality credits outperformed given the move in Treasury rates. Our traders observed some increased selling across sectors and ratings to maintain cash levels amid continued outflows from the asset class. The primary market was quiet with no new deals announced. It was also a subdued week in the bank loan market, as new collateralized loan obligations drove most of the buying activity. New issuance was manageable as only a couple of new deals priced, and loan funds reported negative flows.

Shares in Europe snapped three weeks of losses as signs that the economy is slowing cast doubt on whether central banks would seek to increase interest rates aggressively. In local currency terms, the pan-European STOXX Europe 600 Index advanced 2.40%. Major stock indexes were mixed. France’s CAC 40 Index rose 3.24%, while Italy’s FTSE MIB Index gained 1.52%. Germany’s DAX Index, however, was little changed. The UK’s FTSE 100 Index climbed 2.74%.

Core eurozone government bond yields fell, as weaker-than-expected Purchasing Managers’ Index (PMI) readings sparked fears of an economic slowdown and prompted the market to pare expectations for policy tightening. Peripheral eurozone government bond yields broadly tracked core markets, as did UK gilt yields. Record UK inflation and a drop in consumer confidence intensified fears about the economic outlook, exerting further downward pressure on yields. Norway’s central bank raised interest rates by a larger-than-expected 50 bps to 1.25%.

Germany steps up emergency energy plans

Germany moved to the second “alarm stage” of its emergency plans to reduce gas consumption and increase storage inventories of the thermal fuel after Russia sharply reduced pipeline flows. Sweden and Denmark joined Germany, Austria, and the Netherlands in implementing measures aimed at countering a supply squeeze and averting winter shortages. In addition, Germany, Austria, and Romania moved to reopen some coal plants for electricity generation.

Data point to deepening economic slowdown in Europe

S&P Global's Flash Eurozone Composite PMI, which gauges services and manufacturing activity, fell from 54.8 in May to 51.9 in June—its lowest level since February 2021. (PMI readings greater than 50 signal expansion.) The decline was driven by a sharp drop in business confidence and new orders. Manufacturing output contracted for the first time in two years. Demand for services also cooled.

Consumer confidence in the eurozone unexpectedly tumbled to -23.6 points in June, according to an early estimate published by the European Commission. This sentiment reading was near the nadir hit in April 2020, early in the coronavirus pandemic, and likely reflected the effects of soaring inflation. In Germany, the Ifo Institute’s Business Climate Index slipped to 92.3 in June from 93.0 in May, with manufacturers expressing concerns about energy costs.  

UK inflation surges; business confidence slumps

UK inflation accelerated to a record 9.1% in May as food costs rose at the fastest rate in 13 years. Meanwhile, the S&P Global/CIPS UK Flash Composite PMI remained at a 15-month low of 53.1 in June, as businesses struggled with falling orders. Consumers reined in their spending, the Office of National Statistics reported, with the volume of retail sales falling 0.5% in May from April.

Japan’s stock markets registered gains for the week, with the Nikkei 225 Index rising 2.04% and the broader TOPIX Index up 1.68%. Sentiment was supported by continued expectations that the Bank of Japan (BoJ) would keep its monetary policy ultra-loose, despite upward trending consumer prices and the yen at fresh lows. June Purchasing Managers’ Index data showed a strong expansion in business activity in the services sector, also providing a boost. However, fears that aggressive monetary policy tightening by the U.S. Federal Reserve could lead to a global recession kept risk appetite in check.

The yield on the 10-year Japanese government bond fell to 0.23%, down slightly from the previous week’s 0.24%. The yen remained near a 24-year low against the U.S. dollar, finishing the week at the high end of the JPY 134 range. BoJ Governor Haruhiko Kuroda reiterated his view that recent rapid yen moves were undesirable and that the central bank hoped to respond appropriately on currency markets in close cooperation with the government.

Core consumer inflation exceeds target for second consecutive month

Japan’s core consumer price index rose 2.1% year on year in May, topping the BoJ’s 2.0% inflation target for the second consecutive month, as positive contributions increased in non-fresh food and household durables. The contribution from energy declined during the month.

The minutes of the BoJ’s April monetary policy meeting released during the week showed that, while inflation expectations had risen—particularly in the short term and at a more moderate pace over the medium- to long-term—many members expressed the view that underlying inflation, excluding such factors as energy, remained relatively low. Members shared the recognition that there was no change in the BoJ’s stance—for the time being, it would closely monitor the impact of the coronavirus pandemic and not hesitate to take additional easing measures if necessary.

As campaigning for Japan’s July 10 upper house election kicked off, Prime Minister Fumio Kishida reiterated the view that, under the current circumstances, the status quo on monetary policy must be maintained. He also said that the government will prioritize the implementation of measures aimed at cushioning the impact of high energy and food prices.

Services sector activity expands, but manufacturers signal softer upturn

PMI data showed strong expansion in services sector business activity in June as border restrictions related to the coronavirus pandemic were eased. While there was a moderate improvement in operating conditions in the manufacturing sector, growth in output slowed amid weaker demand due to the impact of coronavirus restrictions in mainland China and the pressure on supply chains.

Chinese stock markets advanced on stimulus hopes after President Xi Jinping pledged to roll out more measures to support the economy and minimize the impact of COVID-19. The broad, capitalization-weighted Shanghai Composite Index added 1.0% and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, rose 1.97%.

The yuan was marginally firm at CNY 6.69 per U.S. dollar from CNY 6.70 last week. The yield on the 10-year China government bond dipped to 2.81% from 2.83% a week ago after the People’s Bank of China (PBOC) injected seven-day reverse repos totaling CNY 60 billion into the financial system. The PBOC kept its benchmark lending rates unchanged to avoid further divergence in monetary policy as other global central banks have started hiking interest rates to battle inflation. Analysts believe that Beijing is wary of risks that the yuan will depreciate and that capital outflows will accelerate if it reduces rates to support a slowing economy.

At a virtual BRICS (Brazil, Russia, India, China, and South Africa) Business Forum, President Xi stated that China will “strengthen macro-policy adjustment and adopt more effective measures to strive to meet the social and economic development targets for 2022 and minimize the impacts of COVID-19.” Separately, China’s Finance Minister Liu Kun said that Beijing will accelerate fiscal spending and the sale of special local government bonds.

Many analysts have lowered their growth forecasts for China after the country’s zero-tolerance approach to the coronavirus led to widespread lockdowns that disrupted economic activity and global supply chains this year. A survey by the European Union Chamber of Commerce in China revealed that 23% of European companies were considering shifting their current or planned investments outside of China due to the country’s coronavirus policy.

In economic readings, an official index that tracks apartment and house sales posted year-on-year declines for 11 months, the longest losing streak since China created a private property market in the 1990s, according to Bloomberg. The persistent property slump has raised fears that it poses a greater risk to China’s economy than the recent coronavirus lockdowns.

Colombia’s president-elect strikes conciliatory tone amid market worries

Colombia’s financial markets traded down following the victory of former left-wing guerilla Gustavo Petro in the June 19 presidential runoff election. Petro gained 50.4% of the vote to edge out conservative populist Rodolfo Hernandez Suarez .

Petro’s campaign, including his promise to end oil exploration, had worried investors, but T. Rowe Price emerging markets sovereign analyst Aaron Gifford said that the president-elect struck a conciliatory tone in his acceptance speech, in which he said that there would not be any persecution of his political opponents after he takes office on August 7. On the economic front, Petro said that his government will develop capitalism in Colombia and that there would not be any expropriation of private property. However, Gifford noted that Petro’s intentions for increasing growth through production and investment (especially in the agricultural, tourism, and renewable energy sectors) seemed to be geared toward providing more resources for redistribution.

Gifford said that he will be monitoring the makeup of Petro’s cabinet for clues about the direction in which the new government is headed, but he believes the early contenders to be appointed finance minister look promising. Moreover, the Colombian congress could provide a check on any radical proposals that Petro puts forth as his allies only make up about a quarter of the legislature.

Mexico’s central bank hikes rates to fight inflation

Mexico’s central bank raised its key lending rate by a record-high 75 basis points (0.75 percentage point) on Thursday in an effort to contain high inflation. The bank has raised rates 375 basis points over the past year, lifting its benchmark rate to 7.75%. The headline inflation number for the 12 months ended in mid-June came in at 7.88%, well above the central bank’s 3.0% target. Policymakers also released a revised forecast that shows inflation peaking at 8.1% in the third quarter this year before slowly trending back to the 3.0% target in 2024.