U.S.

Stocks volatile as investors keep a close eye on inflation

Stocks remained volatile in light summer trading, as investors absorbed inflation data and the first major second-quarter corporate earnings reports. On Thursday morning, the S&P 500 Index touched its lowest intraday level since June 22 but rallied sharply to end the week. Technology stocks were among the best performers in the index, helped by solid gains in Apple. Energy stocks underperformed as international oil prices fell to levels not seen since before Russia’s invasion of Ukraine. T. Rowe Price traders noted that Monday saw the lowest trading volumes to date in 2022.

Anticipation over the week’s important inflation data dominated sentiment even before the reports’ releases beginning Wednesday, according to our traders. Wednesday morning’s data uniformly came in hotter than expected, sending markets sharply lower. The Labor Department reported that the consumer price index (CPI) rose by 9.1% over the 12 months ended in June, the highest increase since 1981, with prices jumping 1.3% in June alone. While an 11.2% jump in gas prices in June was partly to blame, core (less food and energy) inflation also surprised on the upside (0.6% versus 0.5%) and picked up from May’s pace.

Thursday’s producer price index (PPI) signals were more mixed. Headline producer price inflation rose 1.1% in June, more than expected and its highest pace since March. The increase was heavily concentrated in energy prices, however, and some prices fell sharply—for example, softwood lumber prices fell 22.6%, and prices for chicken eggs tumbled 30.2%.

Americans’ inflation expectations appear to moderate

Friday’s inflation data seemed to be interpreted as unambiguously good news, helping to spark a solid rally to end the week. Both import and export prices rose significantly less than forecast in June, while a gauge of manufacturing activity in the New York region indicated healthy expansion alongside a deceleration in both prices paid and prices received. According to the University of Michigan’s preliminary survey of consumer sentiment, Americans’ five-year inflation expectations had declined sharply in early July to 2.8%, their lowest level in over a year. The decline seemed to feed expectations that the Fed would move less aggressively than feared at its next policy meeting, raising rates by 75 basis points (0.75%) rather than the 100 basis points futures markets had begun to indicate.

The Michigan survey indicated that Americans felt marginally better about their financial situation than they had in June. The index defied consensus expectations for another decline and rose to 51.1 off a record low 50.0. Consumers also appeared more resilient in the face of higher prices than expected—retail sales grew 1.0% in June, above expectations if still not on pace with inflation. Core retail sales (excluding cars, gasoline, building materials, and food services) rose 0.8% after declining in May.

Treasury market recession signal strongest in two decades

The yield on the benchmark 10-year U.S. Treasury note fell over the week, as an inversion in the closely watched 2-year/10-year segment of the Treasury yield curve, considered by some to be a recession signal, reached its widest level since 2000. (Bond prices and yields move in opposite directions.) Tax-exempt bonds traded higher through most of the week but lagged U.S. Treasuries. According to our traders, demand remained strongest at the front end of the municipal yield curve, aided by incoming cash from summer coupon payments and maturing bonds. Municipal mutual funds industrywide received net positive flows, according to Refinitiv Lipper’s latest weekly measure—a welcome change for municipal bondholders following a protracted period of elevated redemption activity.

According to our traders, the investment-grade corporate bond market opened the week with a cautious macro tone ahead of inflation data releases. Higher-than-expected CPI and PPI prints weighed on macroeconomic sentiment; however, our traders noted that investment-grade corporates remained resilient. Technical conditions were constructive amid healthy levels of overnight inquiry from Asia, with a focus on longer-maturity credits, as well as relatively subdued primary issuance.

According to T. Rowe Price traders, high yield bonds fared relatively well despite equity weakness amid renewed recession fears. No new deals were announced over the week. Our traders reported generally positive sentiment in the bank loan market despite broader macro volatility, the equity sell-off, and the flight to safety ahead of the June CPI report. Our traders noted that collateralized loan obligations continued to be an important source of demand, and most buyers were primarily focused on higher-quality and defensive sectors.

U.S. Stocks

^{This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.
Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price's presentation thereof.}

Europe

Shares in Europe were flat to lower as central banks stepped up interest rate increases, raising fears of a global recession. Over the five days ended July 15, the pan-European STOXX Europe 600 Index ended 0.80% lower, while Germany’s DAX Index pulled back 1.16%, France’s CAC 40 gained 0.05%%, and Italy’s FTSE MIB dropped 3.86%. The UK’s FTSE 100 Index declined 0.52%.

Core eurozone bond yields fell as worries grew that a cutoff of Russian gas might push European economies into a recession. Markets pared expectations for policy tightening as a result, causing core bonds to rally. UK government bond yields broadly tracked core markets. Peripheral eurozone bond yields ended broadly level. Italian 10-year bond yields fell in tandem with core bonds earlier in the week but then sold off after Italy’s ruling coalition collapsed.

The euro broke below parity with the U.S. dollar for the first time in two decades as fears of a global recession intensified. Bank of France Governor François Villeroy de Galhau said on broadcaster franceinfo that the European Central Bank is monitoring the euro’s decline because of its impact on inflation. He also suggested that the move in the currency pair is not necessarily due to the euro’s fundamentals. “When we look at what’s happened since the start of the year, it’s not so much the euro that’s weak,” he remarked, “but the dollar that’s strong, notably because it is traditionally a safe haven.”

Germany fears Russia may not reopen gas pipeline after maintenance

Russia closed the Nord Stream 1 gas pipeline supplying Germany for scheduled maintenance work until the following Friday. The German government is concerned that Russia may not fully reopen it on that date in retaliation against European sanctions, which could force Germany to impose rationing on industries and households to preserve winter stockpiles. Russia has already cut the flows to 40% of the pipeline’s capacity, citing delays in the return of equipment being serviced in Canada by German company Siemens.

The European Commission (EC) will hold an extraordinary summit on July 26 to discuss a coordinated gas savings plan aimed at preserving European reserves should Russia cut off supplies.

EC cuts growth forecasts, sees faster inflation

The European Commission lowered its economic forecasts for Europe and raised its prediction for inflation due to the continuing adverse impact of Russia’s invasion of Ukraine. According to its summer forecasts, gross domestic product (GDP) in 2022 is unrevised at 2.7% but is now seen slowing sharply in 2023 to 1.5% instead of to 2.3%, as previously forecast. Inflation is predicted to accelerate to 8.3% in 2022, up from a previous forecast of 6.8%. The rate for 2023 is also raised to 4.6% from 3.2%.

UK economy unexpectedly grows

GDP in the UK unexpectedly expanded 0.5% in May, after contracting 0.1% in April, a sign that the economy may avoid contraction in the second quarter, as predicted by the Bank of England. The Office for National Statistics said health services helped to boost growth, with a large rise in doctor appointments. Travel agencies and road haulers also reported increased activity.

Italy government falls,; Draghi to form a new coalition

Italy’s ruling coalition fell, and Prime Minister Mario Draghi resigned, after the Five Star Movement boycotted a vote on a cost-of-living bill. The right-wing party said that the government had not offered enough money to help businesses and households hit by high energy prices. Draghi will now attempt to form a new majority after President Sergio Mattarella rejected his resignation.

Japan

Japan’s stock market returns were positive for the week, with the Nikkei 225 Index rising 1.02% and the broader TOPIX Index up 0.27%. World leaders offered their condolences, and Japan mourned its former and longest-standing prime minister, Shinzo Abe, who was shot and killed on July 8 while campaigning for the parliamentary upper house election. On July 10, the ruling Liberal Democratic Party (LDP) increased its seat count in the election, winning a majority with its coalition partner Komeito. The result signaled strong support for Prime Minister Fumio Kishida of the LDP and his government’s policy priorities, with the focus on lifting growth likely to remain unchanged.

In another sign of policy continuity, Bank of Japan (BoJ) Governor Haruhiko Kuroda reiterated the central bank’s commitment to its ultra-loose monetary policy, stating that it will not hesitate to take additional easing steps as necessary. The yield on the 10-year Japanese government bond fell to 0.23% from 0.24% at the end of the previous week. With the BoJ’s dovish stance diverging from the aggressive tightening pursued by the U.S. Federal Reserve, the yen weakened to around JPY 138.8 against the U.S. dollar (from about 136.1 the prior week), having hit a fresh 24-year low during the week.

Ruling LDP-Komeito coalition retains comfortable majority

Japan’s ruling LDP-Komeito coalition retained its comfortable majority in the parliamentary upper house election, signaling strong public support for Prime Minister Kishida’s government and its policy agenda. According to T. Rowe Price Japanese equity specialist Daniel Hurley, “The election victory is likely to consolidate the LDP’s power and ability to implement many of the reforms championed by Abe and the party designed to stimulate the economy after decades of deflation. With more political capital and popular support, Kishida’s government should also be able to push forward in more politically sensitive areas, such as restarting nuclear power plants and continuing to open Japan’s borders to tourism.”

Kishida calls for the restarting of nuclear reactors

With electricity supply forecast to tighten, Kishida called for the restarting of as many as nine nuclear reactors to ease concerns about a power shortage. The government shut down all nuclear plants in the wake of the 2011 Fukushima nuclear disaster. The worst-ever heatwave recorded in Japan has prompted the government to warn of power shortages, as higher temperatures have translated into increased demand for energy, primarily air conditioners. Households and businesses were asked to enter a three-month energy-saving period.

China

Chinese stock markets eased as data revealed that the country’s economy slowed sharply in the second quarter, and a growing movement among homebuyers to stop paying their mortgages hurt property and banking shares. The broad, capitalization-weighted Shanghai Composite Index fell 3.8% and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, fell 4.1%, Reuters reported.

China’s GDP for the June quarter grew a worse-than-expected 0.4% from a year earlier, official data showed, compared with a 4.8% expansion recorded in the first quarter. Friday’s GDP followed reports of a rapidly growing number of Chinese homebuyers who have refused to pay mortgages for unfinished construction projects. Homebuyers have halted mortgage payments on at least 100 projects in more than 50 cities across China as of Wednesday, a sharp increase from just days before, Bloomberg reported, citing researcher China Real Estate Information Corp. The payment refusals for unfinished homes came despite Beijing’s assurance that local governments will get help to deliver property projects on time. Chinese developers are allowed to sell homes before completion, though they are required to put those funds in escrow accounts. 

Other economic data offered a more nuanced snapshot of China’s economy. Industrial production grew 3.9% in June from a year earlier, up from May’s 0.7% rise, while fixed asset investment increased 6.1% in the first six months of the year from the prior-year period, beating expectations. Retail sales rose 3.1% year on year in June and marked the quickest growth in four months after authorities lifted a two-month lockdown in Shanghai. Analysts had expected flat growth after May’s 6.7% drop. Autos led the improvement in retail sales, owing to targeted stimulus and pent-up demand that had been building since last year due to manufacturing problems that have only been recently resolved, according to T. Rowe Price analysts.

Earlier in the week, data showed exports in June rose 17.9% from a year ago, the fastest growth since January and up from May’s 16.9% gain, while imports edged up just 1.0%, below forecasts. June’s export growth reflected domestic demand recoveries unfolding in Southeast Asia and Latin America and inventory buildups in the U.S. and Europe, while the slight imports gain signaled lackluster domestic demand, according to T. Rowe Price analysts.

The yuan currency eased to CNY 6.75 per U.S. dollar from last week’s CNY 6.70 and hit a two-month low during the week, Reuters data showed. The 10-year Chinese government bond yield eased to 2.808% from 2.858% a week ago, according to Dow Jones. China’s overnight borrowing rate in the interbank market dropped to 1.17% last week, the lowest since January 2021, according to Bloomberg.

Other Key Markets

India

Stocks in India, as measured by the S&P BSE Sensex Index, returned about -1.3%. During the week, the government reported that inflation in June was measured at approximately 7.0%, slightly lower than expectations for a reading of 7.1%. Recent declines in energy costs, particularly oil—a major import for India—seem to be the main factor. Nevertheless, 7.0% inflation is well above the central bank’s 4% target and its tolerance range of 2% to 6% inflation, so it would not be surprising to see additional interest rate increases from the Reserve Bank of India. The policy repo rate is currently 4.90%.

Chile

Selling pressure on the Chilean peso, which dropped 12% versus the U.S. dollar in June, intensified during the week. At the beginning of the week, following pressure from some members of the new administration to make its view known regarding the sharp depreciation of the currency, the central bank sent out a communication shedding some light on the situation. However, the statement failed to stabilize the peso.

According to T. Rowe Price emerging markets sovereign analyst Aaron Gifford, policymakers did not commit to any foreign exchange (FX) intervention, but they acknowledged the large dislocation in the exchange rate and committed to continue monitoring the situation. They specifically highlighted external pressures and the fact that Chile is in a vulnerable position given its wide current account deficit, high inflation, and elevated domestic uncertainty. Policymakers also noted that the current FX weakness is particularly worrisome, as it could put stress on other sectors of the financial markets that have preempted other instances of currency intervention (e.g., the social unrest in October 2019).

Later in the week, at the central bank’s scheduled monetary policy meeting, policymakers raised the key interest rate from 9.00% to 9.75% in a unanimous decision. Although the rate hike was slightly larger than expected, it also failed to stabilize the peso. Gifford believes that the post-meeting statement was hawkish but measured, though he notes that policymakers again acknowledged the more challenging external environment that has weighed on both copper prices and the peso. Although central bank officials noted that further currency weakness will provoke more upside pressure on domestic prices in the near term, they again gave no hint of imminent FX intervention, claiming that recent peso depreciation has been absorbed by markets and that the financial system continues to operate with an adequate level of liquidity.

On Friday, however, the Chilean central bank unexpectedly announced that it would implement an FX intervention program and a precautionary U.S. dollar liquidity provision for up to USD $25 billion to facilitate the adjustment of the Chilean economy to uncertain and changing external and domestic conditions. The program starts on Monday, July 18, and is expected to last through September 30. While this could provide some short-term relief to the peso, Gifford believes that the longer-term global backdrop may continue to produce some headwinds.