Macro and markets: mounting challenges for risk assets
Uncertainty caused by the armed rebellion by Yevgeny Prigozhin to pressure the Russian Ministry of Defence has now dissipated although it will keep risks elevated in Russia in the near term and result in a greater consolidation of power under President Vladimir Putin.
Advertisement
From a markets perspective, risk assets remain under slight pressure, and high-yield credit spreads could start to widen again given slightly more hawkish central banks in recent weeks.
EM policymakers - who generally tightened well in advance of their Developed Markets (DM) peers - have begun to signal they are nearing the start of their loosening cycles.
By contrast, DMs are still playing catch-up, with both the Bank of England and Norges Bank unexpectedly hiking by 50 basis points in the week commencing on June 19.
Against this backdrop, market pricing for the trajectory of monetary policy in the G10 space has continued to firm.
Rally Running Out of Steam?
Market Mover: Risk assets continued to soften over the trading week of 19-23 June, but there is little evidence of significant stress.
Looking at the high-yield segment of credit markets, spreads have continued to compress since early May.
Interestingly, this trend has been even more pronounced in the US compared to Europe and emerging markets (EMs), where banking sector problems first arose.
Given that risk assets seem vulnerable to a correction, we would not be surprised to see spreads widen somewhat in the coming weeks and such a correction could be exacerbated by greater expectations of more hawkish monetary policy.
Given still-high inflation and no real stresses, there is little to suggest that we are approaching a meaningful inflection point that could prompt a pivot by central banks.
Policy Sensitive Two-Year Yields Back Near Year-To-Date Highs
Macro Driver Of The Week: Developed market (DM) central banks that began to dial down the hawkishness toward the end of 2022 have become more hawkish of late.
What was common to some of the more dovish of these central banks - most notably the UK, Canada, Norway and Australia - was a concern with issues associated with household leverage and the structure of mortgage markets.
Officials made a bet that they had done enough, hoping that the rate hikes they had implemented - combined with easing supply-side pressures - would see inflation continue its march lower through 2023.
Do DMs Have More Of An Inflation Problem?
However, it is clear that this pivot came too early. Supported by exceptionally tight labour markets, abundant household savings and loose fiscal policy, demand has held up well and inflationary pressures have failed to subside. As a result, these same central banks have been forced back into action.
The Bank of Canada and the Reserve Bank of Australia surprised most by hiking in early June, while last week saw surprise 50 basis point (bps) hikes in both Norway and the UK.
While we do not expect that either the US Federal Reserve or the European Central Bank will be forced into similar pivots, these developments serve as a clear warning of the dangers of loosening too early, something that markets have also picked up on with near-term rate cuts priced out just about everywhere in the DM space in recent weeks.
Major Data Releases
United States: Housing data continued to surprise significantly to the upside of expectations last week, backing our view that 1) residential investment will make a positive contribution to growth in Q223 and 2) the anticipated recession will not be led by housing. Starts surged by 21.7 per cent m-o-m in May to an annual pace of 1.63mn, their highest level in a year.
Home builder sentiment also hit an 11-month high in July, with the index having now risen for six consecutive months. Last week also saw the release of the flash PMIs for June, which surprised somewhat to the downside of expectations.
The manufacturing sector is continuing to struggle (46.3 vs 48.4 in May), while activity is still holding up reasonably well on the services side of the economy (54.1 vs 54.9).
Europe: Aside from the UK inflation figures discussed below, it was a quiet week on the data front in Europe.
The highlights were the flash PMIs for June in the eurozone, which – as in the US – were consistent with an economy that is gradually losing momentum.
The composite PMI dropped from 52.8 to 50.3, driven by a particularly sharp decline in France where service sector activity may now be turning over.
Manufacturing is continuing to struggle across the continent, reflecting the impact from higher interest rates and weak demand from Mainland China in particular.
Over the weekend, elections were also held in Greece, where the right-wing New Democracy secured a landslide victory that gave it an overall majority in parliament. The result – which had been widely anticipated – should prove supportive of Greek bond yields.
Eurozone Economy Has Turned A Corner Lower
