Weekly house view | Long live King Charles III

The UK celebrated the coronation of King Charles III and the Fed hiked rates by 25 bps last week. Signs are that the Fed is considering a pause as it removed the forward guidance that “some additional policy firming may be appropriate” and it left its QT programme unchanged (although strong employment figures and average hourly earnings surprising on the upside bear out Jerome Powell’s comment that the job was “not yet done” on inflation). Following the takeover by JP Morgan of First Republic, the deposit outflow continues into money markets but now driven by retail rather than institutional investors – we will need to watch developments in coming weeks. We note that the BTFP rose to a still elevated USD76 bn, suggesting banking stress remains. Immediate market attention is shifting to the US debt ceiling with the Treasury’s updated X-date now as early as June. Uncertainty over the debt impasse means we are underweight the dollar and overweight gold. (Other sources of uncertainty include the drone ‘attack’ on the Kremlin, the seizing of two tankers by Iran on the Straits of Hormuz and forthcoming elections in Turkey – all of which could contribute to volatility in coming weeks). The two-year US government bond yield is now 1% below the Fed funds rate – normally an unsustainable position. The maker of the iPhone reassured markets on the wider tech outlook as its earnings came out better than feared but our stance on US equities remains cautious particularly at current valuations.

The ECB’s 25bp rate rise was a lower hike than its three previous meetings. Unlike the Fed, Christine Lagarde mentioned that the ECB is "not pausing", implying at least another 25 bps hike in June. This view was reinforced by inflation numbers, although a fall in eurozone retail sales and a slump in German manufacturing activity in March indicates that higher rates are starting to impact the wider economy, despite record low eurozone unemployment of 6.4%. The latest bank lending survey pointed to tighter lending conditions, and especially a large drop in loan demand by corporates. The reporting season has just started in Europe. So far, the message is strong, with positive surprises both at top-line and bottom-line levels and a strong positive margin surprise. 

China’s May holiday spending rose above pre-pandemic levels with 270.2 million passengers – consistent with our theme of a China reopening dividend – yet the Chinese official manufacturing PMI missed market consensus – its first contraction since the beginning of this year. The employment sub-index also dropped further, indicating a still-soft labour market in the manufacturing sector. We think the property sector's recovery is key for broader recovery as it drives household confidence.