September is underway and for financial markets there are many unknowns to ponder
After a few weeks out of the office, mostly spent on French autoroutes, I am back with the usual updates as we move into the final third of the year. Hopefully many of you will have taken a break, not least from some dismal weather in the UK.
Anyway, let’s recap on a month that has seen the market mood gyrating between soft and hard landing narratives, with expectations on the outlook for interest rates, and whether there will be further hikes in the US, UK and eurozone, resulting in significant volatility in bonds. Meanwhile, equities have generally trended lower, giving back a little of the solid returns we have seen in the first half of the year.
Starting with the economic data, the standout news headline was the flash PMI numbers for August, published late last week. We will start to see the full PMI data published from today, but the flash data suggested that resilience across the services sectors in the US, UK and eurozone was cracking. With manufacturing still well in “contraction” territory, the weakness in services dragged the composite figures for both the UK and the eurozone into “contraction”, while the US remained just in expansionary territory. The data certainly challenged the soft-landing narrative that financial markets want to believe, and with the lagged effect of rate hikes still to feed through, further weakness in the PMI data seems likely. Of course, it is worth bearing in mind that even if we do see economies failing to make a “soft landing” – ie, inflation easing without economies falling into recession – there are several grades of “hard landing” that could play out, with a mild recession still the most likely given the data is weakening but not collapsing. That recession may well still be a few quarters away in the US, but for the UK and eurozone it continues to look a little closer on the horizon.
Inflation data continued to ease more rapidly in the US than this side of the Atlantic, with US CPI in July at 3.2%, lower than expected, though core CPI was still 4.7%. In the UK, July CPI fell back, but both headline and core were higher than expected at 6.8% and 6.9% year-on-year respectively. Wage price growth in the UK continued to accelerate, with wages up 7.8% year-on-year in the three months to the end of June. Yesterday saw the eurozone publish flash CPI for August, with the year-on-year rate unchanged at 5.3%, higher than expected. The stickiness of inflation means markets will continue to ponder the path for interest rates for some time to come, particularly within the UK and eurozone.
In the US, the end of rate hikes appears closer, but that does not mean rate cuts are imminent, especially when inflation may well pick up over coming months due to higher energy prices, particularly gasoline.
Looking further afield, the data from China has been distinctly underwhelming, and coupled with more concerns around the property sector, focused on the biggest property firm by sales Country Garden, the mood around the country’s economic outlook remains at best subdued. Country Garden declared significant losses and missed payments on several bonds during the month. Meanwhile, the Chinese retail sales and industrial production data were well below expectations, while property investment fell 8.5% year-on-year. China also reported unemployment rising to 5.3% and chose to stop reporting youth unemployment data – the last time they did so showed an unemployment rate of just over 20% for urban 16-24-year-olds. The persistently sluggish numbers from China suggest stimulus is possible even though the economy appears on track to meet the government’s 5% growth target. Given the restructuring clearly needed in the property sector, the easiest path to short term stimulus – boosting the property market may not be the most prudent one over the longer term.
Despite policy shifts and several speeches from central banks, there have been no major surprises, and as mentioned earlier the second-guessing of what banks plan to do next continues to be a major influence on market mood. The Bank of England raised interest rates, as expected, by 25 basis points to 5.25% at the start of the month. The Monetary Policy Committee said it would continue with its “data-dependent” approach but said policy is now weighing on economic activity, stating that “the current policy stance is restrictive”. This is despite real rates still being negative. The Bank noted that policy needed to stay restrictive for “sufficiently long” to endure inflation returns to the 2% target rate. The CPI and wages data during the month saw markets once again pricing more rate hikes, with another 25 basis points hike at the 21 September meeting fully priced.
The People’s Bank of China underwhelmed expectations with their rate cuts, trimming 10 basis points from the one-year loan prime rate to 3.45%, while leaving the five-year rate unchanged at 4.2%. While the PBC “encouraged banks to boost lending to support growth” they appear unwilling to significantly ease policy for now at least.
In the US, the Federal Reserve held its annual “symposium” at Jackson Hole in Wyoming, where Chair Jay Powell gave a speech on the economic outlook. This time last year Powell’s hawkish comments were a reality check for financial markets assuming rates would not push higher. That contrasts with this year’s messaging which was more in line with expectations, with Powell sticking to the previous script on inflation and rates, reaffirming his focus on restoring pricing stability in the US and the need for high(er) interest rates to achieve this.
Powell said the Fed intends to keep policy at a restrictive level until we are confident inflation is moving sustainably down towards our objective. He highlighted the lag from rate hikes that have already taken place, with “significant further drag in the pipeline”, and noted risks from “both tightening too little and too much”. Market expectations of what the Fed does next have shifted over the month – no further rate hikes are now fully priced, but rates are expected to remain high for longer into 2024. Forthcoming data on employment and inflation numbers scheduled for 13 September will likely shift expectations further, ahead of the next rate setting meeting on 20 September.
September is underway and for financial markets there are many unknowns to ponder. The path of inflation, and how central banks adjust policy as a result, is central to the market mood as we move into autumn. We should also get a lot more visibility about the lagged impact of the interest rate hikes we have seen over the past 12-18 months, which should help settle the soft landing/hard landing/no landing debate.
Outcomes are likely to be different depending on where you look, with Japan and the US appearing relatively strong, while the UK and eurozone appear closer to a stagflationary outcome. China may well see 5% growth, but that does not seem enough to escape the narrative that it will struggle for momentum in the absence of significant stimulus.
Political factors will also come into play. The UK is likely just over 12 months away from the next election, whereas in the US the election in November 2024 is already coming into focus as Joe Biden tries to boost his popularity by spending as much as possible to avert a recession. Meanwhile, his likely rival, Donald Trump, has both political and legal battles to fight.
We should also be mindful of complacency over the Ukraine conflict – the lack of progress in the Ukrainian counteroffensive may well begin to test the patience of western politicians, and Vladimir Putin may well feel emboldened by Wagner leader Yevgeny Prigozhin’s demise as a result of his aircraft “accident”.
We see enough uncertainty in the coming months to maintain our cautious positioning in portfolios. A recession averted does not mean a recession avoided and we still see risks to the downside in terms of the economic outlook, which appear not to be priced into financial markets. Indeed, for markets bad news is currently seen as a positive in that it means rates will be lower in the future, outweighing what that weaker economic growth means in terms of corporate earnings and their valuations. Interesting times ahead…
Have a good weekend,
Regards,
Anthony.
