Stocks experienced a widespread decline due to a souring of sentiment, primarily influenced by a significant surge in longer-term bond yields and concerns regarding a substantial economic slowdown in China. By the end of the week, the S&P 500 Index had retreated by 5.15% from its peak on July 26th. Theoretically, growth-oriented shares should have borne the brunt of the damage, as rising interest rates tend to devalue future earnings. Surprisingly, the Russell 1000 Growth Index held up somewhat better than its value-focused counterpart. Small-cap stocks, on the other hand, suffered the most.
The most noteworthy economic event of the week appeared to be the Commerce Department’s report on July retail sales, which showed a 0.7% increase over the month, nearly double the consensus estimates. Excluding the volatile automotive sector, sales saw a 1.0% rise, bringing their year-over-year increase to 3.2%. While overall retail sales remained relatively flat over the past year due to corresponding increases in the consumer price index, certain categories displayed a sharp uptick in discretionary spending. Notably, sales at restaurants and bars surged by 11.9%, while online purchases recorded a 10.3% increase. Conversely, sales at gas stations plummeted by 20.8%.
Several other data releases during the week hinted at the possibility of a “no landing” scenario, suggesting that the economy might continue to expand without encountering a “soft landing” slowdown or a “hard landing” recession. Industrial production in July grew by 1.0%, approximately three times higher than consensus estimates, marking its most significant gain since January. However, a portion of this increase was attributed to utilities boosting output to cope with exceptionally high temperatures in July. An indicator of manufacturing activity in the mid-Atlantic region signalled expanding factory operations, orders, and shipments for the first time in 14 months. Additionally, nationwide housing starts exceeded expectations.
The release of minutes from the Federal Reserve’s July policy meeting on Wednesday appeared to raise concerns about how policymakers would respond to ongoing signals of economic growth. Investors seemed to interpret the tone of the minutes as generally hawkish, despite Fed officials expressing hopes for “a continued gradual slowing in real gross domestic product (GDP) growth to help reduce demand-supply imbalances in the economy.”
However, determining whether the economy was indeed slowing and to what extent, became somewhat less clear post the Fed’s meeting. The Atlanta Fed’s GDPNow forecast for the current quarter, which is regularly updated based on incoming data, surged to 5.8% as of Wednesday, significantly surpassing the official second-quarter growth rate of 2.4%. Although most experts anticipate a considerably lower actual growth rate in the third quarter, the Atlanta Fed’s “Blue Chip” survey of economists indicated a consistent upward revision of their growth forecasts. Nevertheless, expectations of interest rate hikes, as measured by the CME FedWatch tool, remained relatively stable throughout the week, with futures markets suggesting that rates would likely remain unchanged through the end of the year.
The positive economic surprises pushed the yield on the benchmark 10-year U.S. Treasury bond to its highest level since at least October 2022, though concerns related to substantial bond issuance and supply may have also played a part. Tax-exempt municipal bonds initially held their ground amidst the increased volatility in Treasuries but eventually saw yields rise on Thursday. Nevertheless, new bond offerings attracted strong interest thanks to attractive new issue concessions that appeared to boost demand.
In the corporate bond arena, investment-grade bonds fared worse than Treasuries throughout the week, with the auto sector leading the underperformance. However, roughly half of the week’s bond issuances were oversubscribed.
In terms of local currency, the pan-European STOXX Europe 600 Index experienced a 2.34% decline, primarily driven by growing concerns regarding China’s economic outlook and the possibility of an extended period of elevated interest rates in Europe. Major stock indices in Europe followed suit, with France’s CAC 40 Index slipping by 2.40%, Germany’s DAX recording a 1.62% loss, and Italy’s FTSE MIB giving up 1.81%. Meanwhile, the UK’s FTSE 100 Index took a significant hit, plummeting by 3.48%.
Surprisingly, wage growth in the UK displayed remarkable strength, placing additional pressure on the Bank of England (BoE) to consider further interest rate hikes. Average weekly earnings (excluding bonuses) surged by 7.8% in the three months leading up to June, a notable increase from the 7.4% growth observed in the preceding three months. However, signs of a cooling labour market also emerged, as the unemployment rate unexpectedly rose to 4.2%, up from the previous three months 3.9%.
Annual inflation in the UK slowed down in July, registering at 6.8% compared to June’s 7.9%, primarily due to declining energy and food prices. Nevertheless, underlying price pressures remained robust, with the core inflation rate, which excludes food, energy, alcohol, and tobacco, holding steady at 6.9%. Furthermore, service prices, a key indicator of domestic inflation according to the BoE, accelerated to 7.4%, reaching their highest level since March 1992.
In Norway, the central bank responded by increasing its benchmark interest rate by a quarter of a percentage point to 4.0%, in line with expectations. Following the decision, Norges Bank Governor Ida Wolden Bache hinted at the possibility of another rate hike in September.
Amid growing concerns about the broader repercussions of China’s economic challenges and its troubled property sector, Japan’s stock markets declined during the week. The Nikkei 225 Index dropped by 3.2%, and the broader TOPIX Index experienced a 2.9% decrease. Notably, shares of companies in the tourism industry were particularly affected.
The 10-year Japanese government bond (JGB) yield rose to 0.64%, up from the previous week’s 0.58%. This increase followed the Bank of Japan’s (BoJ) adjustment to its monetary policy in July, effectively allowing JGB yields to have more flexibility by transforming its 0.5% yield ceiling from a strict limit into a reference point.
The Japanese yen also weakened, reaching around JPY 145.5 against the U.S. dollar, compared to approximately JPY 144.9 the previous week. It was trading at levels close to a nine-month low, reminiscent of the situation in September 2022 when Japanese authorities intervened in the foreign exchange market to counter the yen’s decline. Japan’s Finance Minister, Shunichi Suzuki, emphasised that authorities were urgently monitoring market developments and were prepared to respond appropriately, especially to speculative movements that could impact companies’ future plans and households’ prospects.
Japan’s economic growth for the second quarter significantly surpassed expectations. The country’s GDP grew at an annualised rate of 6.0% quarter-on-quarter for the three months ending in June 2023, far exceeding the 2.9% expansion forecasted by economists. This surge in growth was primarily driven by external demand, with net exports outperforming estimates. The yen’s continued weakness played a historic role in boosting exports, particularly in the automotive sector, offsetting weakness in domestic demand, including a decrease in private consumption due in part to rising prices.
In July, Japan’s consumer price inflation moderated compared to the previous month but remained elevated at 3.1% year-on-year (y/y), exceeding the BoJ’s 2% target for the 16th consecutive month. Concurrently, customs exports experienced a 0.3% y/y decline in July, marking the first drop in over two years, primarily due to weak demand from Asia. However, growth in Western markets remained relatively robust. Imports also fell by 13.5% y/y due to decreasing commodity prices.
Chinese stocks faced a decline driven by a prevailing sense of pessimism concerning the country’s sluggish economic rebound. The Shanghai Stock Exchange Index relinquished 1.80%, while the prominent CSI 300 blue-chip index dropped by 2.58%. Hong Kong’s benchmark Hang Seng Index experienced a substantial tumble of 5.89%, marking its most significant weekly decline in five months, as reported by Reuters.
Official data for July showed ongoing weakening economic activity in China. Industrial production and retail sales exhibited slower-than-expected growth in July compared to the previous year. Additionally, the growth in fixed asset investment during the first seven months of 2023 fell short of forecasts. According to China’s statistics bureau, Urban unemployment increased from 5.2% in June to 5.3%. Notably, the bureau chose not to release the youth unemployment rate, which had steadily risen throughout 2023 and reached a record high of 21.3% in June. This decision to suspend the closely monitored indicator raised concerns that Beijing might withhold information considered politically sensitive.
Further exacerbating concerns was evidence of a property market downturn, significantly impacting a vital sector of China’s economy. In July, new home prices in 70 of the country’s largest cities decreased by 0.23% compared to June, marking the first such decline in 2023. Earlier this year, China’s property sector had shown signs of stabilisation, but recent developments have rekindled worries about the strength of the overall economic recovery. Notably, Country Garden, one of China’s major property developers, halted trading on several onshore bonds after failing to meet interest payments on two dollar-denominated bonds the previous week. Meanwhile, China Evergrande, another prominent developer that had experienced a default in 2021, filed for bankruptcy protection in New York, a move intended to safeguard the company from U.S. creditors while it works on debt restructuring arrangements in Hong Kong and the Cayman Islands, as reported by Bloomberg.
Regarding monetary policy, the People’s Bank of China surprised observers by lowering its medium-term lending facility rate by 15 basis points to 2.5%. This marked the most substantial reduction since 2020 and responded to the country’s struggle with weakened demand. Additionally, the central bank decreased the seven-day reverse repurchase rate, a short-term policy rate, by ten basis points.
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