Month: September 2022

Rising rates and the Russia Ukraine conflict continue to take their toll on markets

Bond and equity markets both sold off this week as a number of global central banks raised rates in their continued efforts to combat inflation, with the US Federal Reserve raising rates by 0.75% for the third time in a row, taking the upper bound to 3.25%. The negative sentiment was compounded by Russian President, Vladmir Putin, escalating the Ukrainian war by seeking to annex invaded areas of Ukraine by holding referendums. This was backed up with plans to compulsory draft 300,000 Russian reserve soldiers and make further veiled threats of the use of tactical nuclear weapons.

As of 12pm on Friday, London time, US equities had fallen 3.0% over the week, with the market having given up 85% of its rally over the summer, taking the market to within just over two percent of its low for the year, down 21.2% year to date. Although sterling-based investors have been cushioned from this fall by a magnitude of 18% as sterling has weakened against the dollar. US technology stocks fell by 3.3% over the week, taking their loss to 29% year to date, just above their low point in June. European markets fell by 4.4%, rocked by an increasingly hawkish European Central Bank, and the escalation in the Ukraine war by Russia. UK equities dropped 3.4% as the Bank of England raised rates by 0.5% to 2.25%, whilst announcing that the UK was probably in a recession. Japanese stocks were a comparative bright spot, falling 1.2% as the Bank of Japan maintained its dovish stance, keeping rates on hold at -0.1%, whilst continuing to target a zero percent yield for ten-year Japanese government bonds. Australian stocks fell 2.4%, whilst the emerging markets lost 2.3%.

Government bonds continue to weaken in the face of rising rates

US government bonds sold off, with the 10-year Treasury now yielding 3.76%, a level not seen since 2010. However, it was UK government bonds that took the limelight this week for all the wrong reasons. The combination of a comparatively small rate hike by the Bank of England, and a string of tax cuts announced by the new chancellor of the exchequer, Kwasi Kwarteng, raised concerns about rising UK government borrowing in a rate rising environment. 10-year gilt yields, which move inversely to price, jumped by 0.66% over the week, taking the yield to 3.8%, whilst two-year gilt yields are now trading at 3.96%. German government bond yields rose by 0.28%, taking the yield on 10-year bunds to 2.04%. The Swiss National Bank raised rates by 0.75%, thereby taking interest rates to 0.5% and ending negative interest rates for the first time since 2015. The Bank of Japan now remains the only global central bank still pursuing negative interest rates.

Sterling falls to a 37-year low versus the US dollar

The dollar maintained its upward path, with the dollar index (the dollar versus a basked of internationally traded currencies) rising by 2.3%. Whilst Sterling fell to a thirty-seven year low versus the dollar, trading at just under $1.11, it also fell versus the Euro, trading at €1.13. The Euro also weakened versus the dollar, falling beneath parity to trade at $0.98. However, despite the Bank of Japan being the only major central bank not to be following a tightening path, the Yen strengthened this week, as the Japanese central bank intervened in currency markets to prop up their currency.

Commodities continue to fall on recession concerns

Gold sold off over the week, falling 1.8% to $1,654 an ounce following the latest US interest rate rise. Industrial commodities also sold off as recessionary fears grew in the face of rising rates. Copper fell 1.7%, currently trading at $7,739 a tonne, whilst crude oil sold off, with Brent crude falling by 4.1%, now priced at $87.6 a barrel. European natural gas also fell a further 4.8%, now trading at €178 megawatt hour, although that remains an increase of 172% since the start of the year, and over an eightfold increase since the start of 2020.

Issues under discussion

Trying to put the inflationary genie back into the bottle

To date, 2022 has been one of the worst years on record for fixed income as central banks have played catch up as they try to put the inflationary genie back into the bottle. Many would argue that they were caught napping in the second half of 2021, as loose monetary and fiscal policy from the covid pandemic led to unprecedented levels of demand, colliding with supply chains suffering from the aftereffects of the pandemic. Although there may be some truth in this, they could not have known that Russia was about to invade Ukraine, and the impact this was to have on energy prices.

US rates have moved up swiftly since, with the 10-year yield on US Treasuries now in positive territory having adjusted for future expectations of inflation. Whilst the risk is that central banks increase rates higher than what the market is currently pricing in, the opportunity is that economies start to slow as the higher costs of servicing debt has the desired effect. The cost of a new mortgage has now doubled in the US, this is increasingly likely to be a headwind for the housing market, a key harbinger for the US economy. Therefore, the yield on offer in fixed income markets looks increasingly compelling, both in government bonds, and within areas of the corporate credit market where investors are being sufficiently compensated for the likelihood of rising defaults.

Global equity markets end down for the fourth week in five

A sharp pullback on Tuesday sent the major U.S. stock indices to their steepest weekly declines since June. The market fell for the fourth time in five weeks, with the NASDAQ and S&P 500 dropping 5.5% and 4.7%, respectively. Communication services and information technology shares were hit hardest as Alphabet and Meta Platforms hit new 52-week lows.

Core inflation not done yet

The main event of the week was Tuesday’s consumer price index report, which came in above expectations and softened investors hopes that the economy had moved beyond peak inflation. Headline prices rose 8.3% for the 12 months ended in August versus consensus expectations for an increase of around 8.1%. Of greater concern was that core inflation jumped to 6.3%, its highest level since March and above expectations for a rise of 6.1%. A 0.7% housing cost increase in August was partly to blame, but rising food and medical care prices also contributed heavily. Core producer prices, reported Wednesday, offered a somewhat more hopeful story, continuing a year-on-year decline that began in April, falling to 7.3% in August from 7.6% in July.

The week brought mixed messages on wage inflation, which has been a primary concern of policymakers. Weekly jobless claims, reported Thursday, showed a continuation of labour market strength, falling to 213,000, their lowest level since early summer. Media reports suggested a slightly different picture, highlighting that Goldman Sachs will soon cut jobs, joining a list of large companies, including Ford Motor and Microsoft, planning layoffs.

Recession fears hit the British pound

Shares in Europe pulled back amid signs of a deepening economic slowdown, with the European STOXX Europe 600 Index ended 2.89% lower. Japan’s stock markets fell over the week, with the Nikkei 225 Index dropping 2.29% and in China stock markets fell as currency weakness and downbeat property data overshadowed surprisingly strong factory output and retail sales indicators, the Shanghai Composite Index down 4.2%.

The British pound depreciated against the U.S. dollar, sinking to levels last hit in 1985. Fears of a looming recession contributed to this downward pressure, as did concerns that the Bank of England’s rate policy will continue at a slower pace than that of the US equivalent. Inflation in the UK came in at 9.9% in August. This reading marked a decline from the 10.1% registered in July. Falling fuel prices drove this slowdown. However, core inflation, which excludes food and energy costs, quickened to 6.3% from 6.2%.. The FTSE 100 finished the week -1.56%, aided somewhat by the benefit its many exporting constituents get from a weaker home currency.
The yield of the 10-year U.S. Treasury bond climbed for the seventh week in a row, reaching around 3.45% on Friday. The yield is up from 3.32% at the end of the previous week and from 2.64% at the end of July. The yield curve remained inverted, as the 2-year Treasury yield rose to about 3.87% on Friday—its highest level since 2007. British 10-year government bond yields also increased, to their highest levels in more than a decade, closing at 3.14%.

All eyes on rate announcements

Ahead of next week rate announcements from the US Federal Reserve and Bank of England, investors will be looking for any sign as to where to next for Central Banks. With a 75 basis point hike by the US Federal Reserve very much priced in to current market prices, any indication of a continued aggressive approach into the year-end could unsettle markets further. On the flipside of this, any signs of a slowdown or pause in the current pace of rate hikes, may be met with a sigh of relief and air of calm by markets.

Markets mustered a gain

Markets mustered a gain last week, snapping a three-week losing streak, as the focus remains on Fed rate hikes, inflation, and their implications for the economy ahead. Some moderating inflation fears may have also been at work, and a midweek decline in oil prices which briefly hit their lowest level since Russia’s invasion of Ukraine causing energy shares to underperform within the S&P 500 Index, although the sector still recorded a gain.

Markets snap three week losing streak

US markets posted a gain of 3.6% as investors sort a temporary bottom to the recent market declines. Shares in Europe rose after some countries announced plans to deal with the energy crisis and boost their economies. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.06% higher. Major indexes also posted gains with the UK’s FTSE 100 Index increasing 0.96%. Japan’s stock markets rose over the week, with the Nikkei 225 Index gaining 2.04%. China’s stock markets also rose as tame inflation data and expectations of further policy support prompted buying, with the Shanghai Composite Index advancing 2.4% for the week.
The British pound depreciated further against the U.S. dollar before retracing to roughly USD 1.16, a level near the low hit in 1985. This weakness appeared to stem, in part, from uncertainty about the economic agenda of new UK Prime Minister Liz Truss. The euro rose above parity with the U.S. dollar after the ECB hiked its key rates by a record amount.

ECB raises rates to highest level since 2011

The ECB increased its key interest rates by a record 0.75 percentage point in a bid to curb inflation. The deposit rate now stands at 0.75%, the highest levels since 2011. The ECB explained in its official statement the major step frontloads the transition from accommodative policy rates to levels suited to achieve a return to the ECB’s 2% inflation target. Even so, the central bank indicated that more rate increases are likely.

UK Government intervene in Energy Crisis

New UK Prime Minister, Liz Truss, announced that the government would intervene to help reduce soaring energy costs for British households and businesses. The Financial Times reported that internal government estimates showed the size of the package could be around GBP 150 billion—bigger than bailouts during the COVID-19 crisis and would be funded by government borrowing. In Germany, Chancellor Olaf Scholz said the government will spend EUR 65 billion to shield households and businesses, raising the monies from a tax on electricity companies and a planned corporate tax.

The yield on the benchmark 10-year U.S. Treasury note jumped to its highest level since mid-June at the start of the trading week on Tuesday, attributed to anticipation of a large European Central Bank interest rate increase on Thursday and ended the week at 3.31%.

After another period of market volatility, we know the equity market lows in June priced in a mild recession and pessimism around the economic and earnings outlook. Whilst there may be further weakness in the global economy from here, that doesn’t necessarily mean markets are destined to take another leg lower. However, for markets to stage a durable recovery we need to see consistently declining inflation, resilience in economic growth and corporate earnings, alongside the valuation re-pricing we have seen so far this year.

Global equity markets end down for the third week in a row   

Global equity markets ended last week down for the third week in a row. In particular, markets were hit by news late on Friday that Russia’s Gazprom would be keeping the Russia-to-Europe Nord Stream 1 gas pipeline closed with no timeline for reopening. This followed a more constructive US August jobs report earlier on Friday prior to Gazprom’s announcement.

Fed Committed to raising rates until the job done

On Friday, Jerome Powell told investors at Jackson Hole that the Fed is committed to raising rates and fighting inflation until it “gets the job done.” This past week, financial markets took that message seriously. We saw equity markets fall and bond yields rise somewhat, even after a resilient jobs report on Friday. Friday’s August jobs report from the Department of Labour showed that the economy added 315,000 jobs last month, a number seen as solid though down from a revised 526,000 in July. The unemployment rate rose to 3.7% from 3.5% in July as the labour force participation rate increased. Nonetheless, markets are still forecasting a 75 basis-point (0.75%) rate hike at the September Fed meeting and a terminal fed funds rate of close to 4.0%, with expectations of Fed rate cuts removed from mid-2023 forecasts.

Yen hits lowest level against the dollar since 1998

US equities were down 3.3% over the week, whilst US technology stocks fell 4.2%.  European markets dropped 3.06% and UK stocks were down 2.85%. Japan’s stock markets fell over the week, with the Nikkei 225 Index down 3.46% while the broader TOPIX Index declined 2.50%. Alongside this, the Japanese currency breached the JPY 140 level against the U.S. dollar for the first time since 1998. China’s stock markets fell as coronavirus outbreaks in major cities triggered renewed lockdowns and dampened the economic outlook. The Shanghai Composite Index retreated 1.54% and the blue-chip CSI 300 Index, slipped 2.01%.

The evidence of continued tightness in the labour market helped push U.S. Treasury yields higher, with the two-year Treasury yield reaching levels not seen since late 2007, closing the week at 3.40% whilst the US 10 year reached 3.2%.

US mid-terms could offer hope for investors

Whilst markets may have trouble “fighting the Fed” in the near term, we could see calmer waters in the months ahead. There are two key drivers of a potential U-shaped recovery in markets as we head towards year-end. With the US mid-term elections taking place on November 8th, the period after mid-term elections tends to be positive for markets, regardless of which party wins. Alongside this, should inflation continue to moderate the Fed may pause on rate hikes after its December meeting, which would be a welcome sign of easing financial conditions for investors.