Growth Concerns Weigh on Markets

MARKETS CONCERNED ABOUT GROWTH

Market sentiment continues to fluctuate between economic growth and inflation concerns. This week the focus has primarily been on the risk of a sharper than desired slowdown in growth and, as a result, equity markets have generally been under pressure. A torrid first half of the year for equities has now come to an end. Most markets are down sharply on their end-2021 levels with the US S&P 500 experiencing its worst first-half drop since 1970. In contrast a number of government bond markets have gained ground over the past couple of weeks, although bond yields remain well above their levels at the start of the year (see Chart 1). Finally in currency markets, sterling has ended a difficult first half to 2022 close to its lows for the year versus the euro and the dollar. Markets are still not expecting an immediate respite from monetary policy tightening despite their growing concerns about downside risks for economies. The Australian central bank will give its latest update on Tuesday, which is expected to result in a third successive rate rise, this time by 50 basis points. That is seen as likely to be the first of a number of central bank rate increases in July. The US Federal Reserve, along with several other central banks, is predicted to hike again and the European Central Bank is forecast to initiate the first of a series of hikes. The message from policymakers continues to be that they remain most concerned about higher-than-expected inflation. Consequently, they feel the need to tighten policy aggressively to ensure that the present high inflation does not become embedded in longer-term inflation expectations. That means significant further interest rate rises across a range of any countries before year end are still expected. Increasingly, however, markets are speculating that central banks may go too far and so may be forced to cut rates next year.

The Bank of England’s rhetoric continues to be somewhat more cautious than most of its peers with more of a focus on the need to balance growth and inflation risks. In comments this week BoE Governor Bailey noted his concerns about both and once again suggested that market interest rate hiking expectations may be excessive. However, that seemed to have little impact as markets still expect the BoE to hike rates again, and possibly by 50bp, at its next update on 4 th August with further significant tightening seen as likely before year end.

FED AND ECB MINUTES IN FOCUS

Markets will look for clues about those next monetary policy updates in the coming week. In the UK, several BoE policymakers are set to speak while the minutes of the last Fed and ECB policy meetings in June may provide indications on their future actions. In the case of the BoE speakers, however, some are set to talk about matters other than the immediate interest rate outlook. Moreover, BoE policymakers mostly seem very reluctant at present to issue strong guidance ahead of a policy meeting. So, we may actually learn little new about their intentions for August. The key questions that markets will be looking for answers to in the Fed minutes is why policymakers upped the ante again and hiked rates by 75bp rather than 50bp as had been flagged beforehand and is that move likely to be repeated in July? In justifying that move Fed Chair Powell has cited concerns about rising longer-term inflation expectations. However, one survey that initially pointed to higher consumer price expectations has subsequently been revised down so this may now be seen as less of an issue. Nevertheless, the tone of the minutes is likely to be ‘hawkish’ with the likelihood of further aggressive tightening flagged. The ECB’s minutes will be expected to reflect the guidance given in June? that interest rates are likely to rise by 25bp in July. However, that guidance also indicated that rates may be increased by 50bp in September so the minutes will be watched for further info on what specific criteria will determine the size of that move. The ECB have also promised a new tool will soon be unveiled to combat bond yield spreads widening within the Eurozone. However, detailed work on this began after the June policy meeting so it’s not clear how much detail there may be next week.

PAYROLLS WILL BE WATCHED FOR GROWTH CLUES

The coming week’s data calendar is light. However, next Friday’s US labour market report for June will be seen as important gauge of economic conditions. Fed policymakers have repeatedly stressed that the tight labour market is reinforcing their concerns about inflation. Monthly reports so far this year have confirmed that the labour market remains buoyant but there have been tentative signs in recent weekly unemployment benefit claims data that it may now be turning. However, on balance while we look for weaker employment growth than in May, we still expect a sizeable rise and a further decline in the unemployment rate. Average earnings growth will also be watched closely to see if it confirms recent indications that wage growth may be slowing. In the UK, possibly of most interest will be the results of the BoE decision makers panel, a survey of the views of businesses. This may have a significant impact on the Monetary Policy Committee’s deliberations in August. They will be looking for signs that inflation expectations remain well anchored and indications that inflationary pressures may be easing. The last survey in early May showed an expectation that inflationary pressures would ease modestly before year end but overall remain elevated. They also suggested that recruitment difficulties remained widespread and that overall levels of business uncertainty were still high.

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