Weekly Wrap: Interest rate hikes in focus

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Written by Citadel Global Director, Bianca Botes.

It has been a busy week on the central-bank front, with interest rate announcements from three major central banks. Markets are getting anxious as global growth continues to slow.

Key themes for this week include:

  • The United States (US) Federal Reserve (Fed), the European Central Bank (ECB) and the Reserve Bank of Australia (RBA) all hike rates
  • US jobless claims exceed expectations
  • S&P 500 falls to a five-week low
  • Gold sets sights on record highs
  • Pound on course for strongest levels in nearly 11 months

A BUSY WEEK FOR CENTRAL BANKS

A busy week of rate hikes by central banks, was started by the RBA, which unexpectedly hiked its cash rate by 25 basis points to 3.85% on Tuesday, after keeping rates steady at 3.6% in April. The latest hike marks the 11th time the bank has raised rates in the past year, defying market predictions of a pause in the hiking cycle, while increasing Australian borrowing costs to their highest level since April 2012. The Bank justified its decision by citing concerns over Australia’s continuing high levels of inflation, which currently stand at 7%. The Bank also noted that the Australian labour market remains tight, with the unemployment rate at its lowest point in nearly half a century. The strong labour market has contributed to the Bank’s decision to hike rates and the RBA hinted that there will be further rate hikes in coming months. This narrative, however, is broadly aligned with other central banks, who are basing their rate paths on how their economies and price pressures evolve over time. Currently, projections indicate that Australian inflation will fall to 4.5% this year and then is expected drop further to 3% in mid-2025.

The US Fed followed hot on the heels of the RBA, announcing a widely expected 25 basis point hike on Wednesday. This marked the tenth hike by the Fed, and it brings US borrowing costs to their highest levels since September 2007. In a widely expected change of tone, the Fed indicated that a pause might be on the cards following the latest hike, as economic growth in the US continues to decline. The Fed will, however, take its cues from economic data, and continues to advocate for an inflation rate of closer to 2%. Central Bank officials also noted that although the banking sector is considered to be in good condition and resilient, tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation, with the full impact of these factors remaining unclear at this juncture.

The ECB was last in line this week to deliver their rate decision on Thursday. The ECB also announced a 25 basis point hike, while signaling a slowdown in the pace of rate hikes, but it emphasised that the bank is nowhere near a pause, as inflation in the region remains stubbornly high. Borrowing costs in the European Union (EU) region are now at the highest level since July 2008, with the latest rate hike marking the seventh consecutive hike by the ECB. The ECB reiterated the need to combat inflation despite increasing recession fears in the euro region. In addition to the hike, the Central Bank also announced plans to discontinue the reinvestment of cash from maturing bonds purchased under the €3.2 trillion Asset Purchase Programme from July. Inflation readings for April saw a 7% rise, while core inflation remains close to an all-time high of 5.6%.

DATA IN A NUTSHELL

The US ISM Manufacturing Purchasing Managers Index (PMI) rose to 47.1 in April, up from a three-year low of 46.3 in the previous month and slightly above market expectations of 46.8. The latest reading, however, still indicates that economic activity in the manufacturing sector shrank for a sixth consecutive month, as higher borrowing costs and tight credit conditions have boosted the risk of a recession this year. Taking a look at factory orders, new orders for manufactured goods rose by 0.9% month-on-month in March, rebounding from two consecutive months of declines. The growth, however, fell short of market expectations of a 1.1% climb. Meanwhile, the number of Americans filing for new unemployment benefits rose by 13,000 to 242,000 for the week ending 29 April, surprisingly exceeding market expectation of 240,000.

The consumer price inflation rate in the euro area increased slightly to 7% in April, from March’s 13-month low of 6.9%, a preliminary estimate showed, while the seasonally-adjusted unemployment rate in the euro area decreased slightly to 6.5% in March, marking the lowest rate on record and coming in just below market expectations of 6.6%. This latest figure reflects an ongoing tight labour market, which, coupled with high inflation, gives the ECB further room to hike interest rates. In contrast, producer price inflation in the euro area decreased for the seventh consecutive month in March, decelerating to 5.9% year-on-year. This marked the lowest rate since March 2021.

The United Kingdom’s (UK’s) S&P Global/CIPS UK Manufacturing PMI was upwardly revised to 47.8 in April, from the earlier flash estimate of 46.6 and compared with March’s 47.9. The latest PMI reading shows that the downturn in the UK manufacturing sector continued for a ninth consecutive month. Output fell for the second month in a row, led by declines of consumer and intermediate goods producers, while total new order inflows were down at their quickest pace in three months and employment fell for the seventh month in a row. The UK’s new car market recorded its ninth successive month of growth in April, with an 11.6% increase.

On the local front, the Absa Purchasing Managers’ Index rose to 49.8 points in April, from an eight-month low of 48.1 points in the previous month. The latest reading pointed to the third consecutive month of contraction in the country’s manufacturing activity. “The headline PMI would have deteriorated further if not for a significant improvement in the inventories index, which rose to its highest level since mid-2022”, Absa said. South African total vehicle sales were down by 0.2% from a year earlier to 37.11 thousand units in April. The South African S&P Global PMI slid to 49.6 in April from 49.7 in March, defying market expectations of 50.1 and staying contractionary for the second month due to intense loadshedding, supply shortages, and ongoing price pressures.

EQUITIES TREAD WATER

The Dow Jones shed nearly 450 points on Thursday afternoon, while the S&P 500 and Nasdaq 100 dropped 1% and 0.5% respectively, as worries about banking system stress and a possible Fed-induced recession lingers. Shares of PacWest plunged almost 50% after reports that the California-based bank has been considering strategic options, including a potential sale. Other regional banks also came under heavy selling pressure, including Western Alliance, shedding 40% and Zions Bancorporation losing 10%.

The FTSE 100 fell to a nearly one-month low of 7,700 points on Thursday, with the industrials and heavyweight material sectors dragging the index down. Lingering concerns about the possibility of a recession and financial stability continued to influence markets. Diversified natural resources company, Glencore, was the main laggard on the index, dropping more than 6%, while oil giant, Shell, bucked the trend, rallying more than 1% on the back of strong reports.

European shares also ended the day in the red on Thursday, with the STOXX 600 falling by 0.4%, while Germany’s DAX 40 lost 0.5%. The dip in the market followed the ECB’s decision to hike interest rates by 25 basis points. ECB President, Christine Lagarde’s hawkish remarks during the press conference following the decision suggested that the bank was not going to pause the rate-hiking cycle anytime soon. On the earnings front, car manufacturer, VW’s revenues surged; steel producer, ArcelorMittal’s EBITDA beat expectations; and shipping company, Maersk’s earnings came in above expectations.

In contrast, Japan’s Nikkei 225 Index rose 0.12% to close at 29,158, while the broader TOPIX Index fell 0.12% to 2,076 on Tuesday, with Japanese stocks struggling for direction amid weak cues from Wall Street on Monday night. The benchmark indexes reached multi-month highs on Monday as the Bank of Japan’s dovish stance spurred a selloff in the yen, boosting the outlook for export-heavy Japanese industries and making Japanese assets more attractive to foreign investors.

The JSE FTSE All Share index extended losses to close around 1.2% lower on Thursday, as losses posted by the financial sector, retailers and industrial sector more than offset strength in resource-linked sectors. Investors also digested the outcome of the latest policy meetings from major central banks. Traders continue to assess economic data from key economies and corporate earnings.

GOLD EYES RECORD HIGHS

Gold rose to a record high of $2,070 before paring gains back to the $2,050 mark on Thursday, its strongest level  in 14 months, amid renewed turmoil in the US financial sector and dovish bets for the Fed. Repeated threats to the stability of US banks reinforced the view that the Fed will not be able to maintain borrowing costs at an elevated level for much longer, pressuring the dollar and reducing the opportunity cost of holding non-interest-bearing assets such as bullion.

West Texas Intermediate Crude futures traded around the $69.00/barrel mark on Thursday, recovering faintly from an over one-year low of nearly $63.60/barrel touched overnight on Wednesday, lifted by some dip-buying strategies and a weaker dollar. Fundamentals in the oil market however remain clouded by worries of a demand-draining recession. The interest rate hike by both the Fed and ECB this week added to market fears that tighter financial conditions will push major economies to contract. In addition, the latest International Energy Agency report showed that gasoline inventories in the US unexpectedly jumped last week by 1.743 million barrels, indicating softening fuel demand. On the supply side, Russian crude exports jumped above four million barrels/day last week despite the country’s pledge to reduce production.

Copper futures hovered below $3.90/pound, remaining near the four-month low of $3.80/pound traded on 25 April, on the back of a firmer dollar over the past week and mounting evidence of poor demand from top consumer China. According to National Bureau of Statistics (NBS) PMI data, China’s manufacturing sector contracted unexpectedly in April, magnifying concerns over the country’s economic slowdown despite the reopening. In addition, the Yanghsan copper premium has more than halved since mid-March to $23.00/tonne, indicating oversupply due to muted demand for physical deliveries. In addition, weak growth in the US and expectations of tighter policy by the Fed hurt projections for stateside demand.

POUND SETS SIGHTS ON HIGHEST LEVEL SINCE JUNE 2022

The US Dollar Index regained some lost ground to trade at 101.5 on Thursday, following two days of losses, as investors processed the latest economic data and monetary policy decisions ahead of the monthly jobs report due today, which is expected to indicate the addition of 180,000 jobs in April, the lowest addition since December 2020.

The euro weakened marginally against the US dollar, falling to around $1.10/€, after the ECB raised interest rates by 25 basis points in response to persistently high inflation. The increase, however, marked a deceleration in the tightening pace, following three consecutive hikes of 50 basis points, as tighter lending conditions have started to impact the economy. Despite this, President Lagarde confirmed that the ECB will continue its rate-hiking cycle, suggesting there is more ground to cover.

The British pound continued its ascent to approach $1.26/£, a level not seen since June 2022, following indications from the Fed that it may pause its rate hike cycle soon. Meanwhile, the Bank of England is expected to raise interest rates further, taking the base rate up by 25 basis points to 4.5% next week. Investors also see a 50% chance of borrowing costs reaching 5% by August. In March, Britain’s inflation rate remained above the 10% mark for the seventh month in a row, while the Markit PMI survey for April showed that UK output grew at its quickest rate in a year, indicating that the economy may avoid a recession in 2023.

The South African rand gained some ground on Wednesday, to trade around the R18.20/$ not far from a near one-month high of R18.00/$ seen on 31 March, as the dollar shed some value following the Fed’s latest policy decision, which opened the door to the potential for a pause in rate increases. Locally, the South African Reserve Bank is likely to continue its interest-rate hiking cycle, with traders fully pricing in a quarter-point increase later this month after headline inflation surprised markets and accelerated for the second consecutive month to 7.1% in March. The Monetary Policy Committee has repeatedly stressed the importance of bringing inflation within its target range of 3% to 6% and anchoring expectations around the midpoint of this range. In addition, local policy around Russia, ongoing loadshedding and sluggish economic growth continues to weigh on the local unit.