October can be a tricky month for stock markets, if you believe in seasonality, and this week is usually the worst, with the 10th ad 12th historically the worst days for stock market performance in October. Thus, it should be no surprise that US stock markets have turned negative at the end of the Monday session. In fact, the UK index has been defying seasonal weakness, and has been the recent out-performer in Europe due to its large energy sector. The themes at the start of this week include sharply rising commodity prices, the price of Brent crude oil continues to surge after last week’s Opec meeting and it is up 1.6% on Monday, just below $84 per barrel, WTI is at a 7-year high and broke above $80 per barrel on Monday, while cotton is also at a 10-year high. Elsewhere, rising sovereign bond yields is also a theme to watch out for, with the 10-year US Treasury yield surging above 1.6% at the end of last week, and the UK 10-year Gilt yield rising to its highest level 2019 on the back of some hawkish talk from Bank of England policy makers.
When will the commodity rally run out of steam?
Rising commodity prices are fuelling inflation fears, which is why sovereign bond yields are rising at such a fast rate. Interestingly, both of these themes are feeding UK asset prices, with the FTSE 100 outperforming its European peers, as mentioned above, and sterling is also higher, although GBP/USD is resisting pressure to move above $1.37 at this stage. After comments from BOE members in recent days, the market is pricing in 50 basis points of tightening from the BOE by year end, which means that the UK is likely to lead the way with unravelling pandemic era support via interest rate hikes as the first weapon of choice. Stocks globally did well last week, which is impressive given the backdrop of rising inflation and Treasury yields and the disappointing jobs data that came out on Friday. While we don’t want to spend too long talking about last month’s labour market report, the 194k increase in jobs for last month is the second straight month where jobs growth stalled, so what is going on?
Why US jobs growth misery may not stop the Fed from tapering
Analysts think that this is a still a supply side story, with the Delta variant that ripped through the US in the summer still having an impact on the labour market as workers continue to think about the risks of returning to work. The report was not all bad, the unemployment rate fell to 4.8% from 5.2%, however sluggish jobs growth could lead to a rockier road ahead for the US economy. The impact of Delta was felt in the data, with the hospitality and leisure sector only creating 74,000 jobs in September, as people avoided travel and eating out. Public education jobs fell, which appears to be due to rising early retirement rates or teachers switching to the private sector, rather than schools actually cutting the number of teachers that they require. Overall, this jobs report suggests that Congress should vote in favour of President Biden’s social spending plan, as that may be one way to get people back to work and to increase jobs numbers in the coming months. However, this does not mean that the US economy is on its knees, even at 194k monthly jobs, that is hardly a warning sign that the US economy is struggling. In fact, some optimists argue that the weak jobs figure for September is purely down to Covid, and the rise in wage growth to $30.85 average hourly earnings, which is an annual gain of 4.6%, could attract more people back to work now that Covid infection rates seem to have stabilised in the US. The surge in US wages is also a sign that the Federal Reserve may continue with tapering its asset purchases and signal a rate hike could come in 2022, as rising wage pressure is likely to fuel prolonged inflation.
US economic data watch
There could be some volatility in the week ahead, with events on Wednesday that could spark some big moves across markets. US inflation data is released on Wednesday and the market expects the annual rate of headline inflation to remain at 5.3%, with core inflation remaining steady at 4%. The risk is that economists have under-estimated the price pressures in the economy, especially after the jump in wage growth last month from 4% to 4.6%. If inflation does surprise on the upside, it could merely be the tip of the iceberg after commodity prices surged once again on Monday. With inflation running this hot, it is hard to see how the Federal Reserve can justify not tapering its asset purchases and signalling a rate hike when it meets later this month. Thus, strong inflation could weigh on US stocks, particularly those sensitive to rising interest rates like tech stocks. The consumer will also be scrutinised this week, with September retail sales released on Friday. The market is expecting a drop in consumption last month, with a 0.2% fall expected over the month. This could partly be down to the Delta variant ripping through the US at that time, thus it could be seen as yesterday’s news. Of course, a sharper decline in consumption could set alarm bells and weigh on the US stock indices as a whole. Also released on Friday is the University of Michigan consumer sentiment survey for October. This is expected to show a slight increase to 74 from 72.8 in September, however this would still be an historically depressed figure. Consumer sentiment in the US has been deteriorating since peaking in April, and it could fall further this month after US benchmark crude oil hit a fresh 7-year high on Monday. Rising gas prices and the prospect of tighter interest rates is usually a bad mix for consumer sentiment, so we think that the bias could be the downside for this one.
Polexit: risks and the prospect of euro weakness spiralling
In the FX space, the pound has been rising on the back of hawkish talk from the Bank of England, however, its recent rise faded slightly on Friday as sharp upswings in commodity prices unnerved investors and drew some demand into safe havens such as the dollar. Even so, the pound remains relatively strong vs. the euro right now. The single currency is coming under pressure after a court ruling in Poland said that EU laws were incompatible with the Polish constitution. The ruling has increased concerns that Poland could leave the EU, although the government has said that was not its intention. The ruling rejected the core principle of the EU, that its laws have primacy over national legislation, and it is the most significant challenge to the EU legislature in its history. While Polish voters are strongly in favour of remaining in the EU, the fears are that the government is trying to surreptitiously remove Poland from the EU by challenging the primacy of EU law that could question the legitimacy of recent changes to the Polish judiciary. Of course, the EU Commission could always use Poland’s yet to be agreed EUR 57bn Covid 19 recovery plan as leverage to get the Polish court to reverse its decision, but as yet the Commission has not formally responded to the latest threat towards the EU. A Polish exit, or Polexit could be far more damaging for the EU than Brexit, thus this news is weighing on the euro. EUR/USD is at its lowest level since June 2020, and we could see further downside towards $1.1501 – the 50% retracement of the March 2020 low to the Dec 2020 high. Below here, the 61.8% retracement at $1.1310 comes into view. Political threats to the EU tend to play out in the FX market, thus the bias is lower for the euro, in our view, until the Polish government banks down. If the EU/ Poland issue escalates further, then the euro could be in freefall against both the USD and GBP.
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