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With inflation running high and putting immense pressure on central banks, we saw strong moves from the European Central Bank and the Federal Reserve in July, raising borrowing costs by 50 and 75 basis points, respectively. ECB’s actions thus ended 8 years of negative interest rates for Eurozone countries. Government bond yields, even prior to ECB’s surprise rate hike, abruptly changed course and experienced strong decline in July with US treasuries showing the same dynamics. Thus, after a grueling first half of the year, credit markets finally had an upbeat month. Corporate bond indices recorded monthly gains of 2-3%, while high yield indices rose by 5% in July. S&P 500 and Stoxx 600 grew by 9.1% and 7.6% respectively.
US manufacturing showed better-than-expected reading in July, with four of the six biggest manufacturing industries reporting moderate-to-strong growth during the month, suggesting that the economy was not in that of a bad shape despite the decline in GDP. Yes, the US economy contracted for a second consecutive quarter thus meeting a definition of recession. Gross domestic product decreased by 0.9% on an annualized basis in the second quarter, or a 0.2% decrease from the previous quarter. Meanwhile, the number of workers on the job and the total hours worked decreased – employees worked around 12% fewer hours in July than in June, according to Homebase. The data align with expectations of a slowdown in job growth in July. Nevertheless, latest US nonfarm payroll report showed that the economy produced close to 400,000 new jobs.
Weak demand was behind the decrease in manufacturing activity across the Eurozone – S&P Global final manufacturing Purchasing Managers’ Index decreased to 49.8 in July from 52.1 in June. The new orders index decreased to 42.6 from 45.2 a month ago (the lowest reading since the start of the pandemic) adding to the region’s recession risks. Inflation in the block increased to another record high reading – consumer price growth accelerated to 8.9% from 8.6% a month earlier. While expensive energy remains the major inflationary factor, core inflation, which strips out volatile food and fuel prices, accelerated to 5.0% during the month. While recession looms around the corner, the Eurozone economy grew much faster than expected in the second quarter of 2022 with GDP increasing by 0.7% quarter-on-quarter during the April-June period for a 4.0% year-on-year gain. Stronger than expected growth of French, Italian and Spanish economies offset poor performance of the stagnating Germany.
After bouncing back from yet another Covid-19 lockdowns in June, China’s factory activity contracted in July with energy-intensive industries (petrol, coking coal and ferrous metals) being the main “contributors”. The official non-manufacturing PMI also saw a slight decrease in July. Country’s property market, already struggling with debt crisis among developers and weak homebuyers’ sentiment, was further hit by mortgage boycott – both sales volume and new home prices falling slightly from the month earlier. GDP was up by 0.4% in the second quarter from a year ago, missing expectations, as the economy was struggling mainly due to Covid-related controls.
Last month many were “expecting the unexpected” from the European Central Bank and it did, indeed, produce a certain level of surprise, hiking interest rates back to 0.5% – the level last seen back in 2013. The EUR/USD pair was “heavy” since the very beginning of the month and dropped almost five hundred points before stabilizing just around parity. Overall, the picture looks “unstable” and EUR/USD needs to re-gain the 1.10 area in order to take the downward pressure off the pair, but until then market will be more willing to sell EUR/USD closer to the 1.04-1.06 zone.
Lately Fed has been quite active too, though in July it acted in accordance with market’s expectations. For some time we were talking about convergence of bond yields and interest rate levels. It is now visible that bond traders are rather skeptical about central banks’ fight with inflation though still pricing in at least “some” rate hike at Fed’s September meeting. Consequently, dollar yield curve has inverted thus warning about the risk of a recession ahead, which, in turn, is rarely good for stock market. We already saw brief inversion in April, but July’s occurrence seems more decisive and noteworthy. We would buy short-term US bonds around 3% yield mark. Longer term Bund yields (and other EU bond yields along) still have room to go even lower ahead of next ECB meeting, but charts suggest that at some point yields need to re-visit levels above 1%.
Precious metals had another difficult month. Last time we mentioned short-term risks for gold and silver prices and market indeed saw some selling in July. Gold dropped to $1680 mark quite fast and then quickly recovered to 1770 dollars per ounce. We suspect that for some time market will treat XAU/USD 1700 mark as a support level and 1850 as resistance. Silver took some beating too, reaching its low at around XAG/USD 18.30. The consecutive bounce, though, was fast and impressive, as metal closed the month over 20 dollars per ounce.
Next central banks’ meetings will take place only in mid-September and that gives ample room for new macro data to influence upcoming decisions on rate hikes. Bond market’s rally for the last couple of weeks, while still very young, is quite peculiar against the backdrop of seemingly hawkish central banks. With base effects waning, fall will be a decisive moment as to which direction the market decides to take.