Last Week in Review – August 5, 2022

Last Week In Review

Last week stocks were mixed as a much stronger-than-expected jobs report revived investor concerns that the Federal Reserve will need to maintain an aggressive pace of interest rate hikes to tamp down high inflation. The Nasdaq Composite. Russell 2000 and S&P 500 Index finished with gains, while the Dow Jones Industrial Average and S&P MidCap 400 recorded negative results. Equity markets continued to receive support from above-consensus corporate earnings reports.

Friday’s payrolls report from the Labor Department showed employers added 528,000 nonfarm jobs in July, more than double consensus expectations of around 250,000, and May and June’s estimates were revised higher by a combined 28,000. Following the strong July gains, total nonfarm employment in the U.S. has returned to its pre-pandemic level. The unemployment rate fell to 3.5%, matching its February 2020 level. Job gains were widespread, with leisure and hospitality, professional and business services, and health care showing notable hiring.

US – Markets & Economy

Markets had interpreted Fed Chair Jerome Powell’s comments following the central bank’s July 26-27 policy meeting in a dovish light and priced in more limited policy tightening. However, the strong payroll numbers indicated that the Fed has significant room to raise interest rates. Even before the employment data release on Friday, some Fed officials had pushed back against the market’s dovish narrative and signaled that the central bank is still committed to raising rates until inflation is under control.

In other economic news, initial jobless claims edged up to 260,000, which was in line with projections. Based on Institute for Supply Management (ISM) survey data, service sector growth unexpectedly accelerated last month. Meanwhile, ISM’s reading of manufacturing sector growth exceeded expectations but fell to its lowest level since June 2020.

US – Equity Market Performance

SOURCE: BLOOMBERG. THIS CHART IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. PAST PERFORMANCE CANNOT GUARANTEE FUTURE RESULTS.

US Yields & Bonds

The strong payroll report and hawkish messaging from Fed officials helped drive U.S. Treasury yields higher over the week, outweighing downward pressure from rising U.S.- China tensions following House Speaker Nancy Pelosi’s visit to Taiwan. (Bond prices and yields move in opposite directions.) Meanwhile, the broad tax-exempt bond market traded modestly higher through most of the week. Weekly municipal fund flows industry-wide returned to positive territory during the most recent week measured by Refinitiv Lipper, and continued demand for short- and intermediate-term municipals helped push relative yield ratios between AAA-rated tax-free bonds and similar-maturity Treasuries back below their historical averages.

According to traders, investment-grade corporate bonds were resilient despite an uptick in supply, although the technology sector traded lower amid new issuance from some prominent names. The news that U.S. investment-grade corporate bond funds experienced their first weekly inflow since March 2022 supported the asset class. High-yield corporate bonds benefited from positive cash flows and improved risk sentiment.

US Treasury Markets – Current Rate and Bi-Monthly Change

Interesting News Overseas

Shares in Europe weakened on expectations that central banks would continue to raise interest rates aggressively in a bid to smother inflation. In local-currency terms, the pan-European STOXX Europe 600 Index slipped 0.59%. The major market indexes, however, advanced. Germany’s DAX Index climbed 0.67%, Italy’s FTSE MIB Index gained 0.81%, and France’s CAC 40 Index ticked up 0.37%. The UK’s FTSE 100 Index added 0.22%.

Core eurozone, government bond yields ended broadly level. Yields fell early on due to tensions rising between the U.S. and China over Speaker of the House Nancy Pelosi’s arrival in Taiwan. However, hawkish commentary from Federal Reserve officials helped drive yields up again ahead of some key U.S. data releases. UK gilt yields broadly followed core markets but ended the week slightly higher after the Bank of England (BoE) increased rates significantly and warned a recession could be looming.

The BoE raised its key interest rate by 50 basis points (0.50 percentage points) to 1.75%, the biggest increase in 27 years. It also projected that inflation would hit 13.3% by October because of surging energy prices. The central bank expects inflation to remain “very elevated” through 2023 and recede to its 2% target in two years. It forecast that a recession lasting five quarters would begin this winter.

Japan’s stock markets gained over the week, with the Nikkei 225 Index rising 1.35% and the broader TOPIX Index up 0.35%. Upbeat domestic corporate earnings supported share prices, but concerns about heightened tensions between China and the U.S. capped returns. Export-oriented Japanese firms continued to benefit from a weak yen, which finished the week at around JPY 133 against the U.S. dollar, broadly unchanged from the prior week.

The 10-year Japanese government bond (JGB) fell to 0.16%, from 0.18% at the end of the previous week, reflecting global recession risks. An official from the Ministry of Finance said that, although nothing specific has yet been decided, investors should start preparing for normalization in Japanese bond trading, as the Bank of Japan (BoJ) will one day no longer be the primary buyer of JGBs. The BoJ’s yield curve control policy entails purchasing an unlimited amount of JGBs to defend an implicit 0.25% cap around its zero percent yield target.

The biggest issue globally was the Chinese geopolitical tensions. However, China also had to deal with mortgage boycotts, and tepid economic data kept buyers on the sidelines. The broad, capitalization-weighted Shanghai Composite Index fell 0.8%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, dipped 0.3%, Reuters reported.

U.S. House of Representatives Speaker Nancy Pelosi’s trip to Taiwan infuriated Beijing, which held live-fire drills in the waters around the self-ruled island and imposed sanctions on Pelosi and her immediate family. Chinese chipmakers’ shares jumped as traders bet the government would increase support for the domestic semiconductor industry when the U.S. ramped up efforts to curb China’s rise in chip manufacturing. Last week, the U.S. Congress passed the CHIPS and Science Act, which aims to prop up the U.S. semiconductor industry and contains restrictions on chip firms considering expanding in China.

On the economic front, the official manufacturing purchasing managers’ index (PMI) fell to 49.0 in July from 50.2 in June, below the 50-point mark that separates contraction from growth and the lowest in three months. The non-manufacturing business activity index fell to 53.8 from 54.7 in June, and the composite PMI, which includes manufacturing and services, fell to 52.5 from 54.1.

Meanwhile, the Caixin China General Manufacturing PMI fell to a weaker-than-expected 50.4, although still in the expansionary territory as manufacturing recovered from recent coronavirus lockdowns. The official PMI primarily focuses on large state-owned enterprises, while the private Caixin survey concentrates on smaller, export-oriented companies.

According to property research firm China Index Academy, new home prices and sales volume fell in July from a month earlier. A growing nationwide movement among homebuyers to stop paying mortgages on unfinished projects weighed on sentiment.

Foreign investors continued to cut holdings in Chinese bonds in July and dumped equities for the first time in four months, according to the Institute of International Finance (IIF). Chinese debt outflows totaled around USD 3 billion last month, while USD 6 billion exited other emerging markets, IIF estimated. Foreign outflows from China’s stock markets totaled roughly USD 3.5 billion in July compared with inflows of USD 2.5 billion in other emerging markets. Equity outflows occurred after China reported a sharp slowdown in the second quarter while rising U.S. Treasury bond yields have made Chinese bonds relatively less attractive for investors.

According to Dow Jones, the 10-year Chinese government bond yield eased to 2.752% from 2.775% a week ago. China’s benchmark 7-day interbank repo rate fell below 1.3% during the week, the lowest since May 2020, a decline that analysts attributed to flush liquidity conditions rather than policy easing. The yuan was flat against the U.S. dollar ahead of the July U.S. nonfarm payrolls report on Friday.

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