A full cycle in one week
It felt like we had a full business cycle last week with market euphoria earlier in the week give way to more worries about rising interest rates later on, leaving markets up a percent or so after a 6% round trip. As we have come to expect it was ostensibly dour economic news (and the associated hope of a pause in interest rate rises) that sent markets higher, and it was a stronger than expected US jobs report that sent markets lower (as the market acknowledged that inflation pressures may continue unabated). A number of Fed committee members also sought to disabuse market watchers off any nascent optimism on the rates front. Nevertheless, it was a salient reminder of the kindling underneath markets if the clouds were to clear more permanently one day.
The most significant moves were amongst energy companies which were up on average around 10% here and abroad after the OPEC+ cartel elected to limit oil production in order to keep prices around or above$100/barrel. This meant that both tech stocks and more industrial, economically sensitive stocks moved up and down in sync during the week reflecting the confluence of concerns around interest rate sensitivity, potential debt servicing issues and the rising probability of a recession, especially if energy prices remain high.
During the week there was also a raft of reports highlighting the concurrent strength of some Western economies and potential financial fragility (the UK pension system being a recent example of where these issues have bubbled to the surface). It was perhaps also notable that the New York Fed and the Reserve Bank of Australia both issued reports on (threats to) financial stability in the last week and there is an underlying sense that the policies needed to rein in inflation in the real economy, especially here and in the US, might also break something in the financial economy. In Australia’s case, the RBA’s report focused on housing and while it acknowledged the strong balance sheets of most home owners it also highlighted the rapid fall in borrowing capacity implied by the interest rate rises we have already seen and how that might eventually crimp spending. That was maybe one of the reasons that the RBA surprised markets with a relatively modest 0.25% rise interest rates earlier in the week. The local bond prices firmed on this news even as yields overseas continued to rise, implying that as of now the market believes the RBA won’t have to then accelerate rate hikes later.
One bright note though was in high yield (junk) bonds which had every reason to sell down further but instead credit spreads (which reflect the probability of default)narrowed during the week suggesting that bond investors are perhaps not as worried about the severity of an upcoming recession at a corporate level. This week the US earnings season starts with gaggle of US consumer stocks, like Pepsi and Dominos, reporting along with a few banks and industrials. Analysts will be looking for signs of a slowing US economy and will be particularly focused on the forward guidance from companies and whether they see an imminent recession. However, the big market event of the week will still keep the focus on inflation, with the market braced for a slight rise in core inflation driven by a tight services labour market.