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Article | 06 September 2023 | Investments
Global equities fell as hopes of early cuts in borrowing costs were dashed by hawkish central bank rhetoric and resilient US economic data. US equities lost 1.8% (S&P 500), marking the first monthly drop since February, while the EuroStoxx 50 Index dropped 3.9%. Among developed markets, Japan bucked the downward trend (TOPIX +0.4%) but elsewhere in Asia sentiment was pressured by the outlook for China. Greater China stocks dropped sharply (MSCI China -8.5%; Hang Seng -8.5%) as measures to stimulate growth fell short of expectations.
It was a volatile month for global bonds. In the US, the 10 year Treasury bond sold off sharply, with yields nearing a 16 year high as the US raised its debt issuance target. While news that the US had lost its AAA credit rating also weighed on the market, nonetheless US Treasuries staged a late rally to close the month down 0.9% (10 year bond). In contrast, European bonds eked out modest gains. The 10 year German Bund returned 0.4% over August, although its yield touched the highest level since 2011 mid-month. In general, high yield bonds fared better than investment grade debt.
The US dollar strengthened, as speculation of an early cut in US interest rates was dashed by resilient economic growth and hawkish statements from US policymakers. The euro also rallied against the Japanese yen.
Oil prices rose 1.5% to $86.90 a barrel (Brent crude) as Saudi Arabia extended its production cut for at least another month. European natural gas prices also jumped amid fears of a strike by workers at LNG facilities in Australia. While Europe does not import significant amounts of Australian LNG, there were concerns of increased competition with Asian nations for LNG supplies.
Volatility was little changed over August, with the Vix Index slipping 0.4% to 13.6. The Vix Index remained below the 20 level which is usually viewed to be an indicator of market stability.
ESG (environmental, social and governance) factors appear to be at risk of being given less focus in institutional investment decisions. S&P Global announced it will no longer assign ESG scores to corporate borrowers while several large asset managers have been criticised for a lack of support for ESG related shareholder proposals at annual meetings.
In general, US economic data proved more resilient than expected. Speaking at the Jackson Hole summit of central banks, Federal Reserve (Fed) chair Jay Powell reiterated that US inflation “remains too high” and the US central bank will either need to hold rates at their current level or raise them further to bring inflation down to its 2% target.
China’s economic activity remained under pressure. Exports tumbled 14.5% year on year in July, the steepest fall since the start of the pandemic, while imports fell 12.4% on a year-on-year basis. Meanwhile, China officially returned to deflation for the first time since early 2021, as the consumer price index fell 0.3% in the year to July.
While central banks in the developed world remained hawkish, it was a different story in emerging economies. The Brazilian central bank cut rates in August, having kept borrowing costs on hold at 13.75% for a year. The People’s Bank of China also lowered the One Year Loan Prime Rate by 10 basis points to 3.45%, having reduced rates by the same amount in July.
The European Central Bank meets again in September. Policymakers face a dilemma as to whether to continue to raise rates or pause their rate-hiking cycle for the first time in a year. While the inflationary pressures have fallen sharply from their peak and the economy is likely contracting, the inflation rate remains well above the central bank’s target.
The Fed will be watching inflation indicators before its next meeting in the second half of September. Headline US inflation ticked up slightly to 3.2% in July, but core inflation slowed to 4.7%, the lowest level since October 2021. The core PCE index, the Fed’s preferred measure of inflation, rose slightly to an annualised rate of 4.2%, up from an almost two year low in June.
The Chinese authorities have started to implement measures to stimulate economic activity, but so far the actions taken have not matched expectations. The real estate sector is, once again, the focus of attention with developer Country Garden missing interest payments on its debt, while Evergrande filed for bankruptcy protection in the US.