Equities recovered a little this week as markets scaled back interest rate expectations on early signs of an economic slowdown, with the manufacturing sectors outlook weakening in recent company surveys, as both employment intentions and new orders have waned. However, a key US jobs report is due out later today, the non-farm payrolls, for which investors will be looking for signs of easing that might provide an indication as to whether the US Federal Reserve can step back from its aggressive rate rise intentions.
As of 12pm on Friday, London time, US equities rose 2.0% over the week, whilst the US technology sector jumped 4.4%. European equities climbed 2.0%, whilst UK equities were flat. However, in a week when the Prime Minister Boris Johnson finally caved into pressure to resign following question marks over his integrity, more domestically focused mid cap stocks rose 1.0%. Japanese stocks held onto gains of 2.3%, despite the tragic news of former Prime Minister Shinzo Abe’s assassination, having been shot dead whilst at a campaign event for the Liberal Democratic party. The Australian market also managed to rise by 2.1%, despite the general weakness in commodity prices. Emerging market equities increased by 0.2%, with India rising by 3.0%, whilst China fell by 0.9%.
Within government bond markets the difference between 10-year US Treasury yields and 2-year yields went into negative territory for the third time this year, which is considered a reliable indicator of a forthcoming recession within the next eighteen to twenty-four months. The yield on 10-year US Treasuries rose towards the end of the week to 2.98% ahead of the US jobs report, as did German bunds and UK gilts, now trading at 1.26% and 2.13% respectively.
Commodities were generally weak as the market increasingly priced in the probability of a recession. Copper fell 2.8%, taking it down to $7,818 a tonne, iron ore fell 1.3%, and crude oil weakened sharply, with Brent crude falling by 6.0%, to $105.0 a barrel. Gold also fell, as although it is viewed as a haven asset, whilst central banks are looking to aggressively raise rates, the return from holding cash is looking relatively more appealing. Gold is now trading at $1,738 an ounce, having fallen 3.5% over the week.
The Bank of Japan’s (BoJ) yield curve control, where the central bank aims to keep the 10-year yield around zero, has increasingly been questioned by investors. The Yen has weakened dramatically this year, whilst the BoJ remains alone in keeping interest rates anchored at record low levels in order to exit the deflationary trap Japan found itself in over the past decade. Many investors believe this is the last shoe to drop before global yields reach an attractive entry point for investors. However, inflationary pressures, whilst being high in terms of Japan’s recent history, still look very tame versus other developed countries. Headline inflation is running at 2.5% (UK 9.1%, Europe 8.6%, US 8.6%), whilst excluding food and energy, it remains languishing at 0.2%. Therefore, views remain split as to whether the BoJ will relinquish their policy.
Nonetheless, fixed income looks much more attractive as an asset class today than it did only a few months ago, with US Treasury yields close to 3.0% versus the current US interest rate range lying between 1.50% to 1.75%, and the market pricing in a peak in rates of 3.3% in early 2023. Government debt is at least offering defensive characteristics once more, even if corporate debt has scope to sell off further should recession fears rise from today.
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