29 Jul 2024
Jonathan Platt, Head of Fixed Income
Data last week was mixed, with Purchasing Managers' Index (PMI) readings indicating the direction of the major economies.
On the downside, the euro area composite PMI dipped to 50.1 with new orders coming in below the 50 ‘no-growth’ point. To compound the message, euro area business confidence hit a six-month low. The standout feature was weakness in Germany, reflecting problems in manufacturing sector – as indicated by the euro area manufacturing PMI which fell to a seven-month low. Problems in the two largest economies are weighing heavily on these readings.
UK PMIs were better, with improvements in both the manufacturing and services and a rise in business confidence. On prices, the increase in the manufacturer input price PMI was offset by a fall in services whilst there was a fall in the composite output price PMI. The big picture is that the UK is doing a bit better than the euro area. From a Bank of England perspective, the data is mixed news. There is a sense that they want to cut rates but the data is not obliging.
In the US we had both PMIs and Q2 growth data. The PMI series was better than expected whilst output for the second quarter also surprised on the upside, coming in at 2.8% (quarter-on-quarter annualised), up from 1.4% in Q1. Personal consumption was better than forecast but it looks that this was due to households dipping into savings. Inventories also helped – but this could be a double-edged sword: are they wanted or unwanted? The former may be suggested by a strong contribution from business investment. The main negative came from net exports. From the Federal Reserve’s viewpoint, the data suggests that the US economy is coping well with the current level of interest rates. The focus remains on inflation and here last Friday’s Personal Consumption Expenditure (PCE) reading was helpful. The yearly core inflation rate remained steady at 2.6%, with the three-month annualised rate declining to 2.3%. Encouragingly from for the Fed, core services excluding housing also registered a modest decrease due to labour market effects.
Events in China hit the financial headlines last week as 10-year government bond yields fell below 2.2%, driven by interest rate cuts. Recent Q2 GDP data indicates a loss in economic momentum, with construction activity running out of steam. But the real problem is in the service sector, reflecting weakness in household spending. Consumers seem nervous and are pushing up already high saving rates. Rather than rebalancing the economy away from industry, a weak currency is helping increase sectoral imbalances. This does not bode well for harmonious global trade relationships. Elsewhere in Asia, the Japanese composite PMI hit 52.6 in July, back to levels seen in May and consistent with positive rather than flat private sector activity growth. This helped to sustain a rally in the yen, as speculation mounted of tighter monetary policy, and 10-year rates closed the week at 1.07%.
Overall, it was a positive week for government bond markets. US 10-year treasury yields fell below 4.2%, whilst the German benchmark closed at 2.4%. In the UK 10-year rates held at around 4.2%, with a rise in real yields being offset by a fall in implied inflation. In credit, there was little movement in either investment grade or high yield spreads. In sterling, an issue from Severn Trent, the first water utility new issue since the Ofwat draft determination, saw a clearing spread of 1.55%; the issue size was less than expected and the cost higher.
Sunday headlines were full of stories about the ‘black hole’ in UK finances and speculation about how the Chancellor will address this issue. In a sense this is a very old fashioned story – where incoming governments blame their predecessor. With the Introduction of the Office for Budget Responsibility (OBR) we have transparency. Black holes only exist where there is no confidence in their forecasts and spending assumptions. Indeed, the economic picture in the UK seems to be improving and we may see the OBR upgrading growth prospects.
The Olympics kicked off with a spectacular opening ceremony. The UK media were keen to portray it as a damp squib – courtesy of the rain – but there was no doubt that the artistry and settings were magnificent. A bit less schadenfreude would be welcome.
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