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Our views 29 August 2023

JP’s Journal: A flash in the pan, or something else?

5 min read

There are some delightful British idioms. ‘A flash in the pan’ is one such. If memory serves, it relates to the unreliability of flintlock muskets.

Trouble close to home?

Last week’s Purchasing Managers’ Indexes (PMI's) may turn out to be a ‘flash in the pan’ – an unreliable signal. But they are worth looking at in more detail as they painted a downbeat picture. The euro area, UK and Australia readings were consistent with recession, although wage pressures remain elevated. The euro composite PMI fell to 47.0 from 48.6, driven by deterioration in services activity. The UK composite was much weaker than consensus at 47.9, a 31-month low. There was a deterioration in both manufacturing and services, with the latter moving back below 50 for the first time this year. In the US, forward-looking indicators were mixed. New orders indicators fell below 50, although output expectations actually picked up and businesses became more optimistic. Japan was the outlier, recording an improvement to 52.6, driven by a pick-up in services activity.

So, what is happening in Europe? Well, data is downbeat. In Germany, last Friday’s ifo Business Climate survey confirmed the message from weak PMIs; it looks likely that German output will fall again in the third quarter, after stabilising in the second quarter. It is not just a question of weak exports; household spending is coming under pressure and government consumption is proving to be a headwind. So far business investment is holding up well, but I think this will change later in the year. The outlook is less downbeat in France and Italy but remains subdued. In the UK, the latest consumer confidence reading saw a bounce from July’s depressed levels. It may be that higher wages and some lower inflation prints are helping but the broad picture is consistent with other European economies: real consumer expenditure is being squeezed by inflation and higher interest rates.

What has this meant for the future path of interest rates?

In the euro area another hike is expected – but a cut is now priced for next year. In the UK, markets indicate a further 50 basis points (bps) of tightening, with the Bank Rate going to 5.75%. This is down from a 6.5% peak that was briefly implied in early July. However, there is a reluctance to factor in rate cuts; the peak is lower but markets are still saying that it will take time to engineer a cut. I disagree and would see the first downward move next year. 

Trouble further afield?

China remains a mystery. The rebound from the easing of Covid restrictions proved to be a lot more muted than expected. Recent news has highlighted problems in the real estate sector and potential stresses in the financial system. Unlike other major economies, China is experiencing problems associated with falling prices. From a policy perspective, reduced reliance on real estate as a driver of growth is desirable and may explain the government’s reluctance to provide a stimulus. The impact is not just felt in the property sector; falling real estate values have implications for local governments which have relied on rising real estate values to fill their coffers. There has been a policy response – but the cuts in Chinese interest rates have been modest. This may have something to do with the ultra-low margins on which Chinese banks operate and the desire to maintain a profitable sector to foster lending and create more balanced growth.

Could Chinese difficulties spread more widely into the global financial system? The answer is yes, but not likely. The big Chinese banks are well capitalised and have government support. Looking at equity performance, Chinese banking shares have done poorly but have still outperformed US regional banks. Cause for reflection rather than alarm.

Markets remain mixed

European bond markets had a good week, underpinned by the weak PMIs. UK 10-year gilts rallied, with yields ending below 4.50%, 30bps below the level seen in mid-August. Similarly, 30-year rates which had recently nudged above 5% ended the week below 4.7%. In Germany, 10-year yields ended 15bps off their August highs. Reflecting the stronger growth outlook, US yields were little changed with the 10-year finishing around 4.25%.

Investment grade credit markets maintained their recent drift. We saw more weakness in bank credit last week, but more reflective of actual and potential supply rather than concerns about underlying health. High yield markets were broadly unchanged.

So, are the PMIs ‘a flash in the pan’ or conversely a ‘straw in the wind’? I remain of the view that tighter monetary policy has yet to filter through into activity – but am conscious of picking on things that re-enforce a perception and ignoring contrary evidence, such as the resilient performance of the US economy.


This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.