Week in review: what the economic data is telling us

This could be a pivotal week for financial markets. Inflation indicators are moving in the right direction, at least they are in the US and we will have to wait until next week to see if the UK will follow suit, likewise, wholesale prices in Germany are falling, economic data in the UK is not as bad as forecast, Chinese data is suggestive of an economic slowdown at home and abroad, and the dollar had a statistically significant move to the downside. If the Fed has defeated inflation, with a little help from energy prices, could other central banks be next? It also opens the door to a new narrative developing, one where we are close to the peak in this tightening cycle, which is being played out in the FX market, and it could be reflected in the stock market down the line.

Service price inflation finally retreats

As we have mentioned in previous notes, this week’s US inflation report was pivotal. Monthly CPI rose by 0.2% in June, and headline inflation growth moderated to 3%. The Fed will be more heartened by the 0.2% increase in the core CPI rate, which is the smallest 1-month increase in that index since August 2021. Airline fares, communication, used cars and household furnishings saw declines on the month, after some large increases during this period of high inflation, which suggests that inflation could be near its peak. Service price inflation also moderated to a 0.3% monthly increase, which is still a touch high, but is definitely an important step in the direction of normalised inflation levels. The moderation in airline fares and other service sector inflation measures could be a sign that profit-led inflation is coming to an end. If corporates feel like they can’t push margins any further due to a brittle consumer, then it could spell bad news for corporate profit margins later this year, thus weaker inflation could be the kiss of death for the 2023 stock market rally.  

However, the slowdown that may occur in stocks later this year is not in focus as we reach the mid-point of July. US stocks are up some 2.55% this week, spurred by the decline in US inflation and the subsequent reduction in US interest rate hikes. There is now a 96% chance of a US interest rate hike on July 26th, however, expectations for further rate hikes have been dramatically reduced since this week’s inflation report. There is now only a 15% chance of a second hike in rates in September, last week there was a near 25% chance. Thus, the terminal rate looks like it could be 5.25-5.5% in the US, there are also growing expectations that rates will be cut in Q1 2024.

US inflation and the FTSE 100 (yes, there’s a link!)

Weaker US inflation is also good news for the UK stock market. The FTSE 100 is up more than 2% this week, after a torrid few weeks where it has fallen more than 4.6% in the past month. Instead, the FTSE 100 is on course for one of the best weekly performances of the year so far. Why so? This is mostly down to the weaker dollar: it’s helped to boost the pound, and GBP/USD has risen to its highest level since April 2022 and is above $1.31. The stronger pound should help with the UK’s inflation problem, it also helps investors to become that bit more risk-seeking. When the dollar weakens, it can trigger an outflow from US money-market funds and investors instead put their money to work elsewhere. In a risk-seeking environment where we may be at the peak for inflation, the UK is an obvious place to invest. Our economy may be a basket-case and political and financial stability are far from assured, but our stocks are cheap, and that can drive investment decisions if the external environment is considered benign. If this risk-on environment persists, then it could be good news for the UK stock market for the rest of this year.

Dollar demise continues

The impact on the FX market has been fierce. The dollar is down by more than 3% on a broad basis this week, and the dollar index has now broken below the psychologically important 100 level. It’s been a rough month so far for the buck, and momentum seems to be on the downside, which could herald another stage of dollar weakness in the coming weeks. However, it’s worth watching GBP/USD as we await UK inflation data that is due for release next week. If it shows inflation falling by less than expected, then it may lead to fears about the UK economy, which could ultimately be bad news for the pound, even if now, the pound looks unstoppable.

Earnings season fails to lift banking stocks

Elsewhere, earnings season kicked off in the US on Friday, with a decent set of results for the US banks. JP Morgan reported a jump in profit, driven by higher net interest income, which rose by 44% in the second quarter as the largest US bank benefitted from US rate rises. Citigroup and Wells Fargo also reported an uplift in net interest income. Financial stocks didn’t benefit too much from the JP Morgan results, and the sector is down 0.67% at the end of the week. JP Morgan’s share price is up only 0.23%, and Citi’s share price is down 3.7% after its profits were hit by a decline in corporate spending, a round of layoffs and a dearth of lucrative M&A income. Although net interest income boosted bank profits in Q2, if we are near the peak for US interest rates, and rates are cut in Q1 2024, then net interest income could suffer. Since stock market investors are always pricing in the prospects for future earnings, therefore the response to Q2 results have been muted so far.