Cooler at last

A good week for

• Equities rallied in sterling terms, led higher by the US
• Oil gained over +3% in US dollar terms

A bad week for

• Bonds weakened across the board, especially gilts, down over -1%
• The US dollar softened c. -1% on a trade weighted basis

US inflation

US inflation finally showed signs of cooling in July after reaching a 40-year high in June. On a year on year basis, headline CPI softened to 8.5% from 9.1% in June, with a slightly negative month-on-month print. This was largely down to a 4.6% month-on-month fall in energy prices, which pulled down the headline number. The core basket, which excludes volatile components like energy, also slowed, with the annual rate flat at 5.9% and the month-on-month rate falling to 0.3%. This was due to a slowing in owner equivalent rent values, along with tourism costs and used auto prices. Fed Chair Jerome Powell has commented that the Federal Open Markets Committee (FOMC) would need to see a consistent downward trend in inflation in order to have confidence that the pace of monetary policy tightening could slow, so more downward prints will be needed. However, with energy prices down in the US and base effects weighing on annual comparisons, inflation is expected to slow.

US consumer sentiment

While realised inflation may be slowing, providing comfort to the Fed, consumer inflation expectations may remain a source of concern. Friday’s University of Michigan consumer survey revealed that in August consumer expectations of the longer term rate of inflation rose modestly to 3%. In contrast short term inflation expectations, which follow realised inflation more closely, fell modestly to 5%. Higher long term inflation expectations may concern the FOMC as inflation expectations are believed to influence realised inflation via consumer behaviour. However, despite this rise in inflation expectations, consumer confidence actually improved, with expectations rising almost 8 points, even though higher inflation has been shrinking real income growth.

UK economy

The UK economy shrank in the three months to June, but fared better than analysts had expected. UK GDP fell by -0.1% on the quarter, and -0.6% in the month of June. The weakness in June was in part due to the additional bank holiday to celebrate the Queen’s Jubilee. Within the quarter, government spending was a significant drag, with the end of Covid vaccination measures weighing on activity. In contrast, investment held up, growing by 0.6%. While consumption spending was soft in the second quarter, it is likely to soften further, as high energy prices and high inflation weigh on households’ real spending power.

China economy

China continues to battle with Covid cases which weigh on economic activity. Cases are now concentrated in Hainan, Tibet and Xinjiang, but the impact on domestic travel is less than earlier in the outbreak. China’s leadership are expected to turn away from strict health controls at the end of the year, allowing the economy to recover in 2023. However, the pace of booster jabs for the elderly has been slow, leading some to question if relaxing health restrictions will be possible.

Climate

A spate of dry weather in many of the world’s regions is providing a new challenge for economies. Low river levels in Germany have made the Rhine unnavigable, restricting the distribution of commodities including coal, petrol, and wheat. In China, a drought in Sichuan is limiting hydroelectric power generation, with an impact on power supply to the region. In France, high temperatures have impaired the cooling systems in nuclear power plants. Low rainfall has also impacted crops, with some crops spoiling, resulting in higher food prices. This is likely to impact lower income countries most sharply, where food contributes a larger share of personal spending.

Important information
The information contained in this article is believed to be correct but cannot be guaranteed. Past performance is not a reliable indicator of future results. The value of investments and the income from them may fall as well as rise and is not guaranteed. An investor may not get back the original amount invested. Opinions constitute our judgment as at the date shown and are subject to change without notice. This article is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided, Close Brothers Asset Management accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.