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%.
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.
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.
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.
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.
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