Markets Weekly podcast - 23 August 2021

Henk Potts (HP): Hello. It’s Monday, 23rd August and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank. Each week I’ll be joined by guests to discuss both risks and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then discuss the outlook for commodity markets. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

In terms of last week rising geopolitical tension over Afghanistan, deteriorating economic data and renewed lockdowns as a result of the Delta variant along with Beijing’s more aggressive regulatory stance and taper talk at the Fed created a long list of negativity that put pressure on risk assets.

It also pushed the dollar higher and weakened the commodity complex. In terms of equity market performance the Stoxx 600 in Europe posted a loss of 1.5% for the week. That’s the steepest decline since February. The S&P 500 recovered into the end of the week but was still down six-tenths of 1% over the course of that trading week, the dollar index hitting its highest level of the year.

In terms of commodities, well, concerns that the Delta variant, reduced policy support could slow the recovery pushed the Bloomberg Commodity Index to a one month low. Crude fell to a three month low, in fact, registering its longest losing streak since February 2020 last week, Brent trading around $66 a barrel this morning.

There was also weakness across industrial metals, copper trading below the $9,000 ton mark for the first time in five months while the stronger dollar weighed on gold. Gold is now down 14% since hitting a record high above $2,000 an ounce in August last year.

Bitcoin, however, has been bouncing back. It’s now trading above the $50,000 level for the first time since May.

In terms of markets, well, the focus was on the Delta variant which we know was formally designated as a strain of concern back in May of this year. It’s more transmissible than previous strains and has proved to be better equipped at overcoming both vaccinated and acquired immunity.

It’s now been detected in more than 100 countries and has become the dominant strain of new cases worldwide. However, while the Delta wave is clearly a major concern there are significant differences to previous surges. While existing vaccinations may be less effective against contracting the virus there has been a break in the chain between case rates and severe illness.

So if you look at things like hospitalisations and death rates they’ve certainly not been rising at the same rate when compared with the previous wave. This suggests the aggressive restrictions imposed in China, Australia and New Zealand will not automatically be replicated in jurisdictions beyond those that are pursuing a zero COVID strategy.

On the data front in the UK the labour report showed wage growth hit a record high. Demand for staff surged as the economy reopens. Average earnings in the three months to the end of June surged to a record 8.8% year on year and the number of new job vacancies surpassed the 1 million mark for the first time.

We should recognise that the figures are distorted by the base effects of depressed wages of a year ago and compositional effect, with the impact of job cuts being focused on lower paid workers, though the ONS estimates that when accounting for base effects underlying regular wage growth is still between 3.5% and 4.9% so still significantly elevated levels in that area.

We have seen a tangible improvement in terms of the UK labour market conditions. The UK unemployment rate we should remember fell to 4.7% in the second quarter. In July 182,000 employees were added to payrolls. That means that 80% of the payroll’s loss during the course of the pandemic have now been recovered.

However, the real test for the UK labour market will be when the furlough scheme is fully unwound in September. There were still 1.9 million workers on the job retention programme at the end of June.

Improved labour supply driven by the return of inactive populations should help to ease wage inflation in the coming months, but that will be closely watched I think by the MPC.

In fact, pressure on the Bank of England to hike interest rates eased perhaps a little bit last week. July inflation print eased back to 2% year on year compared to that 2.5% increase that we saw in June.

The Bank of England is still forecasting inflation will hit 4% at the end of this year but then start to ease back. We project that CPI will be back below that 2% mark from the middle of next year. Therefore, despite the more hawkish tone that we’ve been hearing from the MPC we still don’t anticipate a rate hike through the course of 2022.

In the US the big number of the week was retail sales which came in substantially below expectations. July retail sales fell 1.1% month on month. Consensus was for a decline but only at three tenths of 1%.

Should appreciate this data series has been volatile due to the impact of stimulus checks. Sales have tended to surge in the months when households received rebate cheques followed by sharp declines in the subsequent months. So part of the decline reflects that the bulk of the stimulus pay outs under the American Rescue Plan has been in the first half of this year.

Also, the Retail Sales Report mostly captures sales of goods so the July decline could also signal a shift away from goods consumption to services as the economy reopens.

However, we can’t simply dismiss the weak report particularly when coupled with a dramatic fall that we saw in terms of consumer sentiment. Rising Delta variant caseload does pose a downside risk to demand in the month ahead which if reflected across the economy could take some of the heat out of demand for an accelerated reduction in asset purchases.

The July FOMC minutes provided greater clarity about the timing of that tapering decision ahead of course of the Jackson Hole Policy Symposium later this week. The minutes showed a full discussion is underway. There was a lengthy debate about whether there’s been substantial further progress towards price stability and full employment objectives.

On full employment participants agreed that substantial progress had not been achieved in July but would be met this year if the economy continues to evolve as projected though the minutes point to the fact that policy decisions remain contingent on the course of the Delta variant.

So in terms of what we expect for the pace, the composition of tapering. Well, we expect the FOMC will either formally announce or firmly signal tapering at the September meeting for that formal tapering to commence in November with proportional pairing of Treasuries $10 billion, mortgage backed securities $5 billion per meeting.

That would be consistent with a conclusion of the purchase programme in September of next year. You could argue the risks are skewed to a faster pace of reduction which could offer the FOMC the optionality of rate hikes in late 2022 if indeed inflation risk does unexpectedly materialise.

So that was the global economy and financial markets last week. I’m pleased to be joined by investment analyst Jai Lakhani to discuss the commodities sector in more detail. Jai let’s set the scene to start off with. What has been driving the recent weakness that we’ve been talking about in terms of commodity markets?

Jai Lakhani (JL): Well, good morning, Henk, and thank you for having me.

Do you remember when we spoke last about commodities in May the Bloomberg Spot Commodity Index was up 63.6% over a one year period. If we take that same number now it’s 32% and 17.4% year to date which is a dramatic difference.

And when we think about what’s really leading, what really led the charge early on it was raw metals such as copper, iron ore and aluminium and they have really taken a turn in the opposite direction.

Coper is as you said down below the $9,000 mark for the first time since April, iron ore prices have been struggling over the past few weeks, and oil has also taken a turn for the worse.

So what’s really been driving this weakness?  It certainly appears to be demand led. The surge in the Delta variant would be a key factor behind this. It’s really putting into question this return to normal and as a result we’ve seen revisions to GDP forecasts lower. You’ve also had it coming at a time where certainly in the UK and the US central banks have turned more hawkish and policy is being pulled back.

And when we think about demand we really have to talk about and acknowledge China. China with lockdown measures that has really questioning demand in the region at a time where momentum in the second world’s largest economy was already slowing down and as we know commodities are pro cyclical so this weakness is really not a welcome environment.

When we think about iron ore weakness as well there is more structural weakness here as China seeks to clamp down on the use of steel and focus on greener practices. We’ve had reports of them unofficially telling regions to keep steel production at the same level as last year. They removed export tax rebates on 23 steel products this month and this is all having an impact on prices in the commodity sector.

HP: You mentioned that oil has certainly been under pressure during the course of the past few weeks. What do you think the outlook here is?

JL: Yes, so after touching $76 a barrel in July, a six-year high on the back of strong demand, you know, the return to normal, supply-side constraints and lower inventory levels Delta has really taken over the narrative with Brent now at $66 a barrel, the lowest level since May. Another reason has been the increased supply that we saw from OPEC+ after they reached a compromise with the UAE that we discussed in the market perspectives.

Although when we think about supply and inventories they do remain fairly tight OPEC+ did agree to release 400,000 barrels per day between August until the end of December next year restoring all the output cuts from the early days of the pandemic at the end of this period.

But in terms of outlook and where do we go from here, well, we certainly have the floor on prices with the increased vaccine rollout still having an effect, tight supply and stretched inventories alongside increased regulation.

When we think about further price rises from here this appears a bit more limited due to the impact they can have on the economic recovery, the incentive for countries such as Russia to deviate from the agreement and the US to come back online and uncertainties remain in respect of the Delta variant and the world’s largest importer of crude, China, the impact it could have on their recovery. It means we see Brent crude averaging $69 in 2021 and $68 in 2022.

HP: We do know of course that gold prices have been having a rough ride during the course of this year. What are the key factors that have been weighing on the precious metal? Perhaps more importantly for investors what role should gold play within a portfolio?

JL: Yeah, certainly gold has had a tough year and it makes sense when we think about the exuberance in markets, ie what we’ve seen a lot of is risk averse investors exiting their ETF holdings. We’ve also had a stronger dollar which makes gold more expensive for non-dollar non-denominated purchasers and somewhat rise in bond yields and this all works against the precious metal.

The reason in the past few weeks it has found some support is because it’s widely perceived as a safe haven. It has become very volatile with the return to normal threatened and those same risk averse investors have come back. But it’s worth mentioning demand for gold is not just driven by investors.

There’s jewellery demand, central bank demand and industry demand and when we think about central bank purchases they remain supportive and lower for longer interest rates also helps to reduce the opportunity costs of holding gold, a zero interest bearing asset.

In terms of jewellery demand if we think about growth in China and India even with growth in China slowing this could still support the precious metal. Putting it to your second part of your question about what does this mean for investors, well, when we think about it from a portfolio perspective we have always kept gold as a diversifier in a portfolio but the key point here is it’s not a driver of longer term returns.

HP: So putting this all together would you say we can now put to rest the commodities supercycle discussion?

JL: It’s a good question and when we had the discussion in May we said it remains too early to tell if the supercycle is present. What we’ve seen since then is that demand may not be carrying the momentum required just yet for a supercycle and it really does hinge on how this variant situation plays out. Putting it to rest for now is probably therefore a plausible conclusion.

Ultimately, however, it’s about the time period you look at and our longer term views they tend to be pretty robust. Even in May we said how, regardless of a supercycle, we were relatively optimistic on copper given the fundamentals of the green economy, the role it’s going to play in the new world, that doesn’t change because of a period of volatility and weaker demand.

We’ve always stressed the importance of gold as a diversifier even when it was significantly weaker than it is now.

HP: Well, thank you, Jai, for your insights. Most commodity prices have a huge influence on costs to consumers and businesses and influence the performance of financial assets so we appreciate you bringing us up to speed. No doubt we’ll have you on again soon.

This week we expect the second estimate of Q2 US GDP growth to be revised higher to 6.9% quarter on quarter from 6.5%, driven by the upward revision to retail sales data for May and June.

On Friday we get US inflation figures. We forecast headline PCE increase by half of 1% month on month in July coming in at 4.2% year on year and look for core PCE to have increased by three-tenths of 1% on the month to come in at an annualised rate of 3.6%.

In Europe we expect the August composite PMI to edge down slightly. We anticipate the services sentiment to stabilise at a high level while manufacturing might decline further due to the persistence of supply bottlenecks.

With that I’d like to thank you once again for joining us. We will of course be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.