Long China, Short the US?
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Hi all, welcome back to the Market Wrap! I hope you’ve had a great summer. There have been some major developments in the financial markets and the global economy over the last few months, so this week’s article will get you up to speed on the most important events that have occurred. Enjoy!
Summer Hiking Trip
The ECB was the first of the major central banks to implement a rate hike in July, its first in 11 years, raising the deposit rate by 0.5%. This move has exceeded economists’ expectations of a 0.25% rate increase and has raised the deposit rate out of negative territory from -0.5% to 0%. The ECB has a difficult job on its hands. With inflation blowing up across Europe, German Producer Price Index (PPI) surged 37.2% Year over Year in July, the ECB is forced to raise rates in an attempt to tame it. However, highly indebted southern European countries such as Italy will struggle to pay back its debts as interest rates rise. Therefore, the ECB has created the Transmission Protection Instrument (TPI) – or in other words, ‘To Protect Italy’ scheme - in order to aid such countries with debt repayments as rates rise.
In late July the Federal Reserve (Fed) also increased the Fed funds rate target range by 0.75% to 2.25 – 2.50%. This was the fifth consecutive month of rate hikes, as the Fed takes a hawkish approach in the fight against inflation. The next meeting of the Fed will be in September, and Fed chair Jay Powell has said that decisions on the monetary policy will be completely “data-driven”. Therefore, any bad news is good news for the stock market. If jobs reports come in weaker than expected, it may encourage the Fed to slow its tightening cycle.
At the beginning of August, the Bank of England’s Monetary Policy Committee (MPC) made a similar move, increasing the base rate by 0.5% to 1.75%. This is the sharpest rate hike the Committee has made since 1995, highlighting the severity of the inflation problem. The central bank also gave an end-of-year inflation prediction of 13% and forecasts that the inflation rate will remain high throughout 2023 and won’t return to near the 2% target until 2024. Buckle in…
Freddo Bar at 50p – Global Emergency Declared
Economic data released last week showed that the US annual CPI was at 8.5% for the month of July. This was a slight decrease from June, mainly as a result of decreasing petrol prices in the US. Although average inflation is still high, this has given hope that price rises in the US may have reached a peak, leading to a relief rally for the stock market. However, this data is unlikely to convince the Fed to take its foot off the gas with rate hikes as it aims to bring inflation back to its 2% target. Core inflation (strips out volatile energy and food prices) was unchanged from June at 5.9% YoY. Wall Street’s expectation of the year-end Fed Funds rate is currently 3.4%.
Across the pond, inflation figures released this week in the UK were not so promising. Annual inflation hit a 40-year high of 10.1% in July. The jump has largely been driven by rising food prices, but core inflation also jumped ahead of expectations to 6.2%. The data has resulted in predictions of another 0.5% rate hike at the next Monetary Policy Committee meeting in September.
In Europe, annual inflation hit a new high of 8.9% in July, up from 8.6% in June. European countries enjoyed growth in Q2 due to a rise in tourism, but it is likely that there will be a slowdown in the second half of the year given the high likelihood of further interest rate rises and the ongoing energy crisis.
Consumer Price Index Year on Year Percentage Change, Source: Statista
Cold Winter Coming
At the end of July, Russian state-owned energy company Gazprom announced its plans to cut Gas flows to Germany through the Nord Stream 1 pipeline by 20%. This has sparked fears of gas shortages across Europe heading into winter. The company stated that a turbine used in the gas pipeline requires repairs so capacity must be cut, but the EU believes that it is a “Politically motivated” move. Rumours of energy rationing have been circulating recently, which will not only affect homes but also business operations. This would guarantee a recession in Europe.
Trouble in Taiwan
China has begun to increase its military presence around Taiwan following the visit of American politician Nancy Pelosi. Taiwan is governed separately from China, but China believes it is part of its territory, so Pelosi’s recent visit has angered the Chinese government and military figures. China is now trying to isolate Taiwan from interaction with foreign governments with increased military presence around the island. An invasion by China would have huge implications, far beyond the stock market.
China Chop Lending Rate
The People’s Bank of China (China’s central bank) this week cut its medium-term lending rate for one-year loans to banks by 10 basis points to 2.75% in an effort to shore up demand. This is following the release of weakening economic performance in the world’s second largest economy, driven by multiple zero-covid policy lockdowns, and a faltering property market. The PBOC has also begun a new Quantitative Easing program in an attempt to improve liquidity and risk-taking in the region, at a time when the west is conducting severe tightening programs to tame inflation. Could it be time to go long China and short the US in The Spark’s portfolio?
Hope you enjoyed this week’s Market Wrap!
Patrick
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.