Concerns surrounding monetary policy tightening weighed on markets in August, with global equities handing back a fair portion of the previous months’ gains as bond yields resumed their move higher. UK-based investors with dollar-based assets were once again shielded from the declines due to a significant sterling depreciation, with the pound experiencing its worst monthly fall since the wake of the Brexit referendum in 2016.
Although the sizable rally since equity markets bottomed around mid-June has been welcome, we remain cautious in the near-term and continue to favour a larger than usual cash position. We have readjusted portfolios to reflect a more defensive allocation as we believe the impact of rapidly rising rates is yet to feed through to company results; while the second quarter earnings season was solid, input prices, and the cost of capital, are rising rapidly, and we expect to see some earnings weakness in the coming quarters.
The recent moves in government bond markets have been particularly volatile. This is partly structural – adjustment to a post-quantitative easing environment – and partly the cyclical impact of dealing with the unexpected rise in inflation. The UK faces the additional challenge of policy instability under a new Prime Minister. Bond prices have fallen sharply, especially for shorter maturities as the two-year gilt yield jumped from 1.71% to 3.00% last month offering a potential alternative to cash.
Stocks pare gains
After starting the month on the front foot, global equities came back under pressure as August wore on. Despite encouraging signs that US inflation may be at, or near, a peak, the Federal Reserve remains committed to raising rates and talked down any suggestion of a big dovish pivot in the coming months. Several voting members of the Fed’s monetary policy committee had expressed this view, but it was chair Jerome Powell’s comments at the annual Jackson Hole symposium which were taken as the strongest signal by investors – approximately half of August’s equity decline followed his speech.
This dashed hopes for a softening in the Fed’s stance should economic activity slow significantly, with the central bank keen to express its determination to keep raising interest rates in order to combat high inflation, even if this triggers a period of economic weakness.
This commitment to a hiking path was reiterated despite some encouraging signs that US inflation may have peaked, with the month-on-month Consumer Price Index (CPI) for July coming in flat at 0%. Following a 1.3% rise in the previous month, this is the first time since October 2020 this metric has not shown an increase. However, the headline year-on-year reading of 8.5% remains substantially above the Fed’s 2% inflation target.
US economic data, on the whole, continues to be pretty strong although declining new orders in manufacturing and softness in housing markets suggest slower growth ahead. The labour market figures in particular display little sign of weakness with two vacancies for every job applicant. The unemployment rate may have ticked higher by 20 basis points in August, but at 3.7% it remains near its lowest levels on record. The pace of job growth also slowed last month, but non-farm payrolls still showed 315,000 roles added.
The combination of relatively strong economic activity, rising interest rates and safe haven status has led to a steady appreciation in the US dollar, recently hitting a 20-year high. This has weighed on commodities, with Gold in US dollar terms declining by around 4% last month.
US equities declined by 4% in August, versus a 3.6% drop for global benchmarks. Tech indices fared slightly worse, as is typical in periods of rising interest rates. The US 10-year yield ended the month back above 3%, rising by just over 50 basis points to close at 3.20%. A 75 basis point hike at the Fed’s September policy meeting is now widely expected by markets with the year-end rate seen around 4% from its current 2.25%-2.50% and only one rate cut is priced-in for 2023.
Sterllng and UK bonds under pressure
There has been a significant move lower in UK bond markets in the past month on a combination of the Bank of England’s commitment to raising rates to combat inflation despite a faltering economy and political uncertainty. Although the latest GDP figures came in better than forecast, they still showed a 0.1% contraction in the second quarter and calls for a UK recession are becoming increasingly vociferous
