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by Tim Sharp,

As the summer months draw to a close, and the cooler temperatures begin to set in, September saw the Fed pause, signalling that the sustained period of interest rate rises may also be approaching an end. Indeed, officials are hoping that policy is now ideally positioned to cool the sweltering inflation we have seen over the past 18 months, without strangling the economy.

Following the rapid rises in interest rates over the past two years, that has seen the FOMC hike 11 times and an incredible 14 consecutive rate increases from the Bank of England, this month potentially indicated a shift in central bank policy.

Looking at the Cleveland Fed’s inflation nowcast (an estimate of current inflation) suggests that core CPI in the US is running at 4.17% YoY[i]. Whilst this is certainly too high for comfort, it does represent a marked decrease from the highs of 9.1% reached in 2022. UK inflation remains a relative outlier in developed markets, with the latest CPI print at 6.3%.

If inflation is still a problem, why pause?

Whilst central banks have taken their foot off the gas…for now at least! We see the messaging as clear; the fight against inflation is far from over. Interest rate increases have a lagged effect, and it does take time to filter through to the broader economy. In our view, this along with greater uncertainty has convinced policy makers that pausing to assess the impact on the economy is the best course of action.

We feel that although rates are unlikely to rise much further from here, the overall tone of policymakers was hawkish. This was in large part due to greater emphasis that rates aren’t going to be coming down anytime soon. Given the continued resilience of the consumer – to the disbelief of many – and the ongoing inflationary risks, we think that central banks have been trying to persuade markets that rates will remain elevated for the foreseeable.

What does all this mean?

With regards to the current higher for longer narrative, we’re not entirely convinced. This will largely hinge on the ongoing strength of the economy. A central assumption being that economic growth will remain robust enough to justify the current rate environment. In our view central banks trying to regain their credibility after the rampant price increases of last year and aiming at all costs to stop higher inflation expectations becoming embedded.

We see signs that longer term expectations are shifting with longer dated government bond yields climbing and the yield curve beginning to steepen. The performance of treasuries over the month was a good example of this, with yields on the 10Y up 10% compared to only 4.1% for the 2Y. This in turn should further raise borrowing costs, tighten financial conditions, and ultimately help cool the burgeoning demand that has driven prices higher in our view.

This can also be seen in currency markets with the dollar continuing to strengthen. The Japanese yen notably continuing its weakness – down 2.35% over the month and 13.49% YTD – as the BoJ pursues a “golden opportunity to dispel the deflationary mindset”.[ii]

So, prices should start to come down?

A significant amount of progress has been made in bringing inflation back towards the two percent target, set by most central banks. However, we see two big ongoing risks that that will keep policy makers awake at night. Wages and energy costs! Meaningful inflation that persists over long periods – as was seen in the 70’s – has historically been driven by elevated wage growth, evolving into a vicious wage-price spiral.  The latest data show’s UK wage growth at 8.5%[iii], a figure that we expect will certainly concern the BoE.

Adding fuel to the fire, the ongoing efforts of OPEC to avoid a capitulation in the oil price have been taking effect. Over the past three months WTI crude oil prices are up over 30%. Where falling energy prices had been a detractor for much of the year, they are now a meaningful contributor.

Whilst a win in the battle against inflation, the most recent PMI figures will provide little consolation. September services PMI data for the UK came in at 47.2[iv] – a figure below 50 representing contraction – with similar figures seen around the Euro area. The US marginally managed to buck this trend, with the PMI’s coming in at 50.2, showing continued expansion.

How does this affect markets?

Looking more closely at markets, September has been a challenging month. Except for the UK, all major equity markets are down over the period. History tells us that rising rates are usually bad news for asset prices. As was seen in 2022, if markets are digesting higher rates over the longer term, then the future profits companies can return to us as shareholders, have a lower value when discounted back to the present.

This is notable when looking at the dispersion of returns over the month. The fast growing, tech heavy Nasdaq has been the worst performer in September – down 4.97% at the time of writing – this makes sense, given much of the value these companies will be able to return to shareholders is likely to be captured far in the future.

The painful performance has not solely been confined to technology with many other broader equity indices and geographies suffering. The S&P 500, DAX and Nikkei delivered -5.22%, -4.33% and -0.93% respectively.

In addition to this, as the return offered by lower risk assets becomes more attractive, investors may be incentivised to de-risk their portfolio’s, we believe this could provide a headwind to risk assets going forward.

This all sounds quite gloomy?

Storm clouds have been gathering on the horizon for some time now and given investors plenty of reason to be cautious. Our positioning has reflected this. However, we see much of the strong performance of markets this year having been driven by the enduring resilience of the economy. Indeed, the Fed more than doubled their 2023 GDP projections from 1% to 2.1%[v]. This is a stark contrast to the 100% percent probability of a US recession by October 2023 forecast by Bloomberg economics last year.[vi]

Markets are forward looking, and although sentiment has been improving, a lot of good news is reflected in prices. US valuations are high by historical standards. The CAPE Shiller PE – a cyclically adjusted ratio for the price multiple on earnings – currently stands at 29.5 for the S&P 500, compared to a historic average of 17.1[vii].

Conversely, in the UK where investor sentiment is particularly negative, we believe valuations are far more reasonable. Whilst the backdrop remains challenging globally, there continue to be companies that offer value. We are confident that attractive returns are available to long term investors through a disciplined and diversified approach.

References, research by Alex Hulkhory:

[i] https://www.ons.gov.uk/economy/inflationandpriceindices

[ii] https://www.boj.or.jp/en/mopo/mpmsche_minu/opinion_2023/opi230728.pdf

[iii] https://tradingeconomics.com/country-list/wage-growth?continent=g20

[iv] https://tradingeconomics.com/forecast/services-pmi

[v] https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20230920.pdf

[vi] https://www.bloomberg.com/news/articles/2022-10-17/forecast-for-us-recession-within-year-hits-100-in-blow-to-biden?leadSource=uverify%20wall

[vii] https://www.multpl.com/shiller-pe

Author: Tim Sharp

Researcher: Jack Williams

Published: September 22, 2023

Another month has passed in the markets, bringing a reversal of sorts with technology leading indices lower, mixed bags of data and an oil price pushing towards $100.

Inflation surprised to the downside, although any optimism was quickly sapped by Jerome Powell’s hawkish rhetoric at the Jackson Hole symposium increasing the odds of future rate hikes from the Fed despite the deflationary data incoming.

In Europe and the U.K inflation data has been more stubborn while both flash PMI’s and retail sales came in much weaker than expected. US manufacturing and services PMI’s also fell into contractionary territory, and we think this will inevitably have some impact on risk assets.

Substantial monetary tightening measures in developed nations may now be taking a toll on economic activity. So far, the key pillar supporting the notion of a robust consumer has been the accumulation of surplus savings resulting from the pandemic, stimulus measures, and reduced opportunities to spend discretionary income during quarantine. However recent data suggests these excess savings could be very close to being depleted.

Our cautious investment strategy has resulted in our abstention from participating in the AI driven rally that swept through the markets during the first half of the year. Nonetheless, we remain optimistic about the potential vindication of our quality-driven, defensive stock selection approach in the latter half of the year. This optimism is underpinned by the fact that valuations continue to remain elevated when compared to long-term historical averages. Moreover, there are ample reasons to maintain a cautious and sceptical stance as an investor in the current market environment.

The US has seen the use of fiscal policy, boosting onshoring through the CHIPS act and seeing an uptick in construction due to the IRA (Inflation Reduction Act), that may have underpinned growth in the shorter term while unemployment remains low, although recent moves in Treasury yields suggest there could be a turning of tides on the horizon.

With bond yields on the rise, this has provided a headwind for equities made worse by the deteriorating landscape in China for investors which earlier in the year was being looked to as the tide that could lift all boats.

Consumer confidence within China remains weak, the countries dismal reopening following extremely tight Covid policies, currently being further amplified by slowing economic momentum.

Many are of the view that policymakers will have to inject some form of stimulus into the economy to avoid a complete collapse in confidence as the nation toils with a spiralling property market, a reversal in globalisation and erosion of geopolitical relations.

We continue to keep a close eye on the deterioration of US/China relations, noting the recent push to increase the number of countries associated with the BRICS (Brazil, Russia, India, China and South Africa) trade group, along with the notable empty chair of the Chinese Premier at the G20 summit as it appears to be distancing itself from western developed nations.

As US influence wanes and developing nations continue to align themselves to alternative regimes and trade groups, the possibility of a dual centred global economy rises. We believe this would be a significant headwind for future global growth through the inefficient use of resources while also increasing uncertainty with regards to security and the obvious increase in geopolitical risks.

We believe the rally seen to date this year within equity markers has been supportive of our earnings trough thesis, with gains in this rally driven near completely by PE expansion rather than growth in earnings.

The question of whether bond yields have returned to mean or will fall in line with inflation and interest rate expectations may determine sector rotation amongst equity allocators. Recent rises in bond yields saw cyclicals come under pressure as risk appetite reduced, however should this reverse and yields back off from their 16-year highs sectors such as Technology, Healthcare and Food Retailers could enjoy a move to the forefront of investors attention.

Guidance from US companies has weakened notably, with margins falling back to non-recession lows and quality of cash flows deteriorating to a point where some are now reducing the size of their buybacks schemes with the worst affected sectors being Technology and Industrials. A recovery in buybacks will probably require an increase in profits growth which looks unlikely to us at present. Financing costs have soared, especially for small and medium sized companies, and debt levels across markets have risen, providing increased headwinds for a market that is priced for perfection. Interestingly buybacks in Japan continue to increase providing a tailwind to equity markets there and underlines our positive stance towards Japanese equities.

Andrew Bailey, Governor of the bank of England revealed rates in the U.K are probably near the top because a “marked” drop in inflation was likely as we move through the year. The surprise drop in August inflation data led to the Monetary Policy Committee voting to leave rates unchanged at its September meeting against market expectations.  The front end of the yield curve reacted positively bringing 2-year Gilt yields lower although the longer end remains cautious due to a rise in oil prices along with resilient earnings.

On a relative basis Gilts appear cheap compared to Bunds and US Treasuries, ASR (Absolute Strategy Research) note in an environment where growth slows, and inflation declines Gilts seem fairly priced given U.K fundamentals.

In our overarching investment strategy, we maintain a favourable stance toward a defensive asset allocation framework. This approach underscores our emphasis on high-quality defensive equities while adhering to a relatively conservative equity allocation in comparison to alternative assets and fixed income instruments. This strategy reflects our commitment to prudent risk management and capital preservation, aligning with our long-term investment objectives.

References

Absolute Strategy Research Investment Committee Briefing – August 2023

by Haith Nori

August was a rather volatile month this year for global markets. The Bank of England continued to increase interest rates. US Federal Reserve Chair Jerome Powell made his speech at the annual Jackson Hole Symposium, reiterating his approach to fighting inflation and the need to endure on the path of increasing interest rates until the 2% inflation target is reached. US debt has been downgraded by Fitch Ratings from AAA to AA+. The Bank of Japan has signalled an end to negative interest rates at the start of next year. Nvidia Corp continues to increase in share price and CEO Jensen Huang comments on the latest partnership with Google. Economists are continuing to downgrade their views on growth projections for China, worsening the outlook for China.

On 2^nd August, Fitch Ratings, one of the three big American credit rating agencies, made the decision to downgrade the US debt rating ’from the highest AAA rating to AA+, citing “steady deterioration in standards of governance.”’ [i] The downgrade was a result of US lawmakers taking their time and negotiating continuously until the final deadline with the issue of the debt ceiling, having placed them on a ratings watch since the start of May when governance worries began. The rating change highlights a slightly higher expectation of default risk from the lowest possible level, albeit still implying a very remote probability.

Following the rate hikes in July by both the US Federal Reserve and the European Central Bank, the Bank of England started off the month (3^rd August) by hiking interest rates in the UK by 0.25% to 5.25%. This was their 14^th hike in a row and leaves interest rates at 15 year highs, with the Bank of England stating that ‘high inflation meant it was unlikely to stop rates any time soon’[ii]. Sterling continued to depreciate after the release of the news, remaining at a lower level for the rest of August. Like Sterling, UK equities also took a negative fall after the release of the news and continued to fall before regaining some of the lost value in the last week of August. Between April to June this year basic wages in the UK rose at their fastest rate of 7.8% which, whilst promising for the general public, also boosts the chances of the Bank of England continuing to increase interest rates. The next meeting for the European Central Bank, US Federal Reserve and the Bank of England will be in mid-September.

On 10^th August US CPI data was released for the 12 months ending in July of 3.2% slightly higher than the June data of 3.0%. Whilst this is a slight disappointment US data is still the closest to the 2% inflation target. On Wednesday 16^th August UK CPI data was released for the 12 months ending in July of 6.8%, down from 7.9% in June, exactly as predicted by analysts. In the Eurozone CPI figures were 5.3% for the 12 months ending in July, down from 5.5% in June. Whilst these figures have been promising all round, Central Banks have stressed the need for interest rates to remain high until inflation is under control. This was the key takeaway to come from Jackson Hole, which took place between 24-26^th August. US Federal Reserve Chair Jerome Powell ‘once again reinforced the “higher for longer” mantra’[iii] in terms of his approach to interest rates and stressed that the committee remain determined to reach the 2% inflation target and are unwilling to stop until the job is done.

The Bank of Japan’s board member Naoki Tamura stated in a speech to Japan’s business leaders, that Japan’s inflation is in clear view of their target and has been ‘signalling the chance of an end to negative interest rates early next year.’ [iv] The comments have been the most compelling as an indication that the Bank of Japan will take action to phase out its unique approach to ultra-low interest rates. Along with the other developed market central banks, the Bank of Japan has a 2% inflation target. Tamura suggests that timing will be important and any such change will be dependent on the conditions of the economy falling into place.

Nvidia Corp, the best performing stock in the S&P 500, currently up 234% since the start of the year, on 31^st August was blocked from selling its A100 and H100 chips to certain areas in the Middle East. This follows an announcement from US President Joe Biden expanding the initial restrictions that were placed on selling to China. Clarification on which specific countries in the Middle East the restrictions have been extended to has not yet been announced. Nvidia stock has continued to increase in share price over the month and the chipmaker has announced (29^th August) a partnership with Google to increase the distribution of its artificial intelligence (AI) technology. This will allow google customers access to the technology that is created by the H100 GPUs. Nvidia CEO Jensen Huang stated “Our expanded collaboration with Google Cloud will help developers accelerate their work with infrastructure, software and services that supercharge energy efficiency and reduce costs”. [v]

Overall, August has been volatile in terms of performance within asset classes. Brent Crude, after the gains made during July remained relatively flat during August. The UK 2-year, 10year Gilt yields and US 10 year Treasury yield have all returned to levels seen at the start of the month following initial increases in yields during August. Sterling continued to depreciate against the US Dollar and Gold also returned to a similar level at the start of the month.

[i] https://edition.cnn.com/2023/08/01/business/fitch-downgrade-us-debt/index.html

[ii] https://www.reuters.com/world/uk/view-bank-england-raises-rates-14th-time-2023-08-03/

[iii] https://www.reuters.com/markets/us/global-markets-view-usa-pix-2023-08-28/

[iv] https://www.reuters.com/markets/asia/boj-policymaker-signals-chance-policy-tweak-early-next-year-2023-08-30/

[v] https://www.cnbc.com/2023/08/29/nvidias-stock-closes-at-record-after-google-ai-partnership.html

Author: Tim Sharp

Researcher: Jack Williams

Published: August 24, 2023

It has been an eventful month with markets, surprising the bears once again.

Asia ex-Japan was the best performing region, the Hang Seng rose 6.1% during this period as market participants overlook weak factory and services data, choosing instead to concentrate on Beijing’s latest measures to stimulate consumption and kickstart what has so far been a lacklustre covid recovery.

We remain somewhat sceptical of China as an investable market with geopolitical tensions, slowing growth (albeit still at a higher rate than the majority of nations) and the commercial property downturn continuing.

As of writing this publication, stories of Country Garden (2007.HK) another real estate behemoth in China missing interest payments and scrapping plans to inject cash into the business emerge, sparking renewed fears of a smaller scale Evergrande calamity or economic downturn in the region as the government struggles to regain confidence.

As a team we are very intrigued by the landscape of LATAM equities currently as we seek to benefit from the downturn in rates and a potential rotation back into equities following a period of elevated rates in the region.  The Brazilian Bovespa index gained 3.3% in July following the BCB’s first rate cut of 50bps, Chile too cut rates the week before with their central bank moving to cut by 100bps and minutes from their July meeting suggesting another 75-100bps could be cut in August.

Global fixed income was flat to marginally weak with credit and emerging market bond index spreads falling slightly more, in line with a risk on environment. Listed infrastructure and real estate recovered 4% during the month, although this was mixed at a subsector level and could well be perceived as bargain hunting at these discounted levels. At the time of writing news is emerging of Buffet moving Berkshire into the housebuilding sector, accumulating stakes worth over $814mm in three US names, Dr Horton (6mn Shares), Lennar (152,572 Shares) and NVR (11,112 Shares).

To our relief, and somewhat in-line with our own expectations, the vice-like grip of inflation eased across markets with EU, UK and US readings all surprising to the downside, U.K headline reached 7.9% while core hit 6.9%.

While still extremely data dependant, it is encouraging to see inflation heading in the right direction and adds weight to the argument that within developed markets we could be close to terminal rates and a pause by central banks (excluding Japan) is likely from here while they seek to assess the stickiness of their remaining inflation. Until recently the soft-landing argument was sneered at by many market participants, however this is now being priced as the most likely outcome.

The BoJ continues to run very loose monetary policy stimulating inflation, although this has been favourable for Japanese equity markets with investors looking for value and positive earnings momentum. We continue to find ourselves attracted to Japanese equities due to the favourable mix found within markets. Japan offers attractive valuations on companies engaged in some of the most pioneering industries to which globally we could be at the inflection point of mass adoption, think Robotics, Technology, AI, Automation, Japan has had a foot in this camp for many years now and this could well be a very interesting period for the region. We see the opportunity mix alongside valuations as a big reason for the Nikkei making 33-year highs back in May.

While the committee kept S.A.A unchanged we took this moment to re-visit some of our inflation beneficiaries including an overview of the  food retail sector. We reviewed the razor-sharp margin nature of the businesses, increased governmental and societal pressure for lower food prices and valuation extensions on equities within the space to P/E’s in excess of 30x. . Falling inflation and persistently tight labour markets also present a significant challenge for these businesses. In summary we see better value and opportunity elsewhere in areas such as UK Pharma.

We have also noticed a growing concern amongst market participants and economists that the ECB could be drastically close to a policy misstep. Many believe the economic picture within the Eurozone economy is not as rosy as it is currently being painted by the central bank, combine this with their aggressive tightening regime and could yield a hefty blow to businesses, individuals and equity markets within the region.

A.S.R (Absolute Strategy Research) undertook a comparison of the global financial crisis and the economy post pandemic; it would seem several of the mistakes witnessed amidst the GFC have not been repeated. Post GFC compared to post pandemic saw a major difference, whereas stimulus in the GFC was removed to be replaced by years of austerity leading household incomes and assets to shrink, following the pandemic fiscal stimulus has remained looser for longer replacing what was a long-term deflationary threat with this new inflationary environment.  ASR expect a slower pace rate of cuts than expected, weaker growth and higher for longer interest rates which could spell volatility for investors given current market expectations.

ASR see the current forecast of rates falling while the economy slows as overly optimistic, siding with central bankers. We see the yield curve inversion being solved by principally falling short term rates. Long dated bonds are also pricing in continued falling inflation, however, if inflation surprises by staying higher for longer (it wouldn’t be the first time sticky inflation has caught investors off guard) then there could be a case to be made for long term yields to remain elevated over a longer term, meaning the unwinding of the curves inversion may unfold in a different manner to that of the general consensus. Long term yields are also likely to remain elevated in the presence of high budget deficits which will require funding through an increase in the issuance of coupon securities.

Advancements in technology along with a strong consumer are two clear reasons the market has performed well this year, however as a team we question the underlying statistics leading many to this outcome. The excess savings figure we see as highly subjective and continue to advocate for the study of credit flows to assess strengths and weaknesses within consumer behaviours.

Despite strong returns year to date, earnings on a forward basis are flat, leaving P/E ratios vulnerable. ASR believe any significant upside in the SPX from these current levels would need EPS growth in excess of 15% or forward P/E’s of 20X, which would see equity indices looking stretched to say the least. Now investors can achieve 5.5% on 3-month cash rates and the trailing earnings yield of the SPX is at 4.16%, we question whether investors are being fairly compensated for the any risk taken when risk free options seem so attractive in these times. When compared to bonds ASR state Global Equity Risk Premium is the lowest since 2007 and US ERP is at a 19-year low. Even with the optimism being created by investors, equities look expensive on a relative basis and are generally priced for perfection in our view. This creates an awkward dilemma for any companies trading on elevated multiples that cannot live up to the image valuations have painted. Any disappointments in earnings or guidance would likely be met with a fierce market reaction.

In aggregate we remain underweight equities, overweight short-dated fixed income and overweight alternative strategies.

by Haith Nori

July saw global markets deliver positive returns. The encouraging news of inflation reducing in the US, Eurozone and the UK has rippled through global equity markets leaving a progressive outcome. Despite the good news, Central Banks have continued to increase interest rates, factoring the latest data into their plans, with the exception being the Bank of Japan who have maintained their stance on ultra-low interest rates. Half-way through the year, second quarter earnings have so far been encouraging and fears of a recession are slowly fading with the idea of a soft landing seeming to be more plausible. Ukraine has, for the time being, not been allowed to join NATO while the war is still active. The trade war between the US and China is levelling up once more and Russia has pulled out of the UN Grain Deal brokered by Turkey last year in retaliation to what they believed to be an attack from Ukraine.

At the beginning of July, China announced that from August they would impose export restrictions on gallium and geranium to US, which are crucial elements for semiconductors and computer chips used in electric vehicles and military equipment. The news came just before Independence Day. China’s decision was ‘widely seen as retaliation for U.S. curbs on sales of technologies to China’[i].  The US announced that they would stop sales to China of high-tech micro-chips in July, as they feel these should not be used by Chinese Military. The retaliation from China could be the beginning of increased tensions between the two countries. Janet Yellen, US Secretary of the Treasury, travelled to China to meet with Premier Li Qiang, in an attempt to repair economic relations between the two countries, stating China had unfair economic practices but China wanted her to meet them in the middle with the development of trade ties. However, whilst Yellen achieved some success talking with some of China’s main economic policymakers, no trade, investment or technology matters have been agreed.

Russia pulled out of UN Grain deal brokered last year by Turkey called “The Black Sea Grain Deal” set up last year after blasts to the Russian bridge connecting to the occupied Crimean Peninsula by what Russia thought to be Ukrainian Seaborn drones. Their decision ‘raised concern primarily in Africa and Asia of rising food prices and hunger’[ii]. Russia has retaliated by targeting grain infrastructure striking the Ukraine grain port of Odesa.

A NATO summit was held in Vilnius, Lithuania on 11-12^th July where the idea of Ukraine joining the NATO was raised. Whilst the thirty-one members of NATO are supportive of Ukraine being part of the alliance, the US has posed strong opinions that they will not ‘let a warring country into NATO and give too firm a timeline commitment’[iii]. It was indicated that Ukraine would be able to join NATO once the war was over. The leaders of NATO have also declared that the future of Ukraine laid in the hands of NATO’s military relationship. Neither Zelenskyy nor Putin were happy with the outcome.

On 12^th July US CPI data was released for the 12 months ending in June of 3% beating expectations of 3.1%. This has come a long way since its level of 9.1% in June 2022! On Wednesday 19^th June UK CPI data was released for the 12 months ending in June was 7.9%, beating expectations of 8.2% and marking a steady reduction. The positive news gave a boost to UK Equities, with housebuilders benefiting the most as market participants believe that upward pressures on interest rates (and thus mortgages) could be abating. In the Eurozone CPI figures were 5.5% for the 12 months ending in June, down from 6.1% in May. Whilst these figures have been promising, Central Banks are still attempting to control inflation.

On 26^th July the US Federal Reserve made the decision to hike interest rates by 0.25% (as expected) to 5.25%-5.50%, the eleventh time in the last 12 meetings. The last time the Federal Reserve had raised rates this high was in 2007 when there was a housing market crash. Jerome Powell has suggested that this is perhaps not the end and will review if rates are to be raised again in September stating ‘We’ll be comfortable cutting rates when we’re comfortable cutting rates, and that won’t be this year’[iv]. Powell still believes there is a pathway towards a soft landing, which is where inflation falls without a recession being caused as a result. On 27^th July the European Central Bank continued their path by increasing interest rates by 0.25% to 3.75%, this being the ninth consecutive hike in a row and has taken them to twenty-three-year highs.

On 28^th July the Bank of Japan’s Governor Kazuo Ueda decided not to change their ultra-low interest rate policy, maintaining overnight interest rates at -0.1%. He also made the choice to marginally loosen their yield curve control (YCC) by buying 10-year Japanese Government Bonds at a rate of 1.0% in fixed-rate operations, rather than the previous 0.5% rate, shocking markets. By promising more flexibility in the YCC, this is their method for controlling long-term interest rates as ‘This effectively expands its tolerance by a further 50 basis points, signalling the BOJ would let the 10-year yield rise to as much as 1.0%.’ [v] The next meeting for the Bank of England will be at the beginning of August where markets are expecting a 25 basis point hike.

Overall, July saw a positive performance across asset classes. Brent Crude, after starting the month at levels of c.$74 per barrel, increased to over c.85 during the month. UK 2year Gilts have reached a yield of over 5%, with the 10-year yield reaching highs of c.4.65% and US 10-year Treasury note c.4.048%. During July Sterling continued to hit its highest levels over this past year, reaching over c.1.31 against the US Dollar. Gold also regained some of its lost value in June.

[i] https://www.reuters.com/markets/commodities/chinas-rare-earths-dominance-focus-after-mineral-export-curbs-2023-07-05/

[ii] https://www.reuters.com/world/europe/russia-carries-out-air-strikes-second-night-ukraines-odesa-port-governor-2023-07-18/

[iii] https://www.cnbc.com/2023/07/14/zelenskyy-absurd-comment-how-nato-pressured-ukraine-to-show-more-gratitude.html

[iv] https://www.reuters.com/markets/rates-bonds/fed-poised-hike-rates-markets-anticipate-inflation-endgame-2023-07-26/

[v] https://www.cnbc.com/2023/07/31/strategist-boj-should-move-to-new-normal-sooner-current-policy-is-very-harmful.html

by Haith Nori

June saw global markets deliver mixed performances, albeit generally reacting positively to the US Debt ceiling issue being resolved at the end of May. A key aspect during this month has been central banks taking their next steps to control inflation. Japanese equities have reached their highest point since August 1990, up c.29% since the start of 2023 with Warren Buffet spotting value in the country and increasing the size of his existing positions in several of Japan’s largest firms. Back in the US, Apple has now reached a market capitalisation of over $3 trillion for the first time ever, assisting with the continued technology rally since the beginning of the year.

On 13^th June US CPI data was released for the 12 months ending in May of 4%, 0.9% lower than that of April, still on the downward trend since June 2022 (9.1%). US. Federal Reserve Chair Jerome Powell is still fixated on achieving a 2% inflation target. On 16^th June Eurozone CPI data was released for the 12 months ending in May of 6.1%, a reduction from April’s 7.0%. On 21^st June UK CPI data was released for the 12 months ending in May remained at 8.7%, unchanged from April, missing expectations of 8.4%.

On 14^th June the US Federal Reserve made the decision to keep interest rates unchanged at 5.00%-5.25% following ten consecutive meeting hikes. Global markets reacted positively to the news with many participants believing a pause was a sensible idea given the huge increase in base rates over the past year. On 15^th June the European Central Bank also continued on its path, increasing interest rates by 0.25% to 3.5% (this being their eighth straight hike in a row). ECB president Christine Lagarde suggests further hikes are likely in July’s meeting. This is the highest level of interest rates in 22 years for the European Central Bank. Following suit, on 22nd June the Bank of England also made the decision to increase interest rates by 0.5% to 5% from 4.5% being the 13^th time in a row that the Bank of England has increased interest rates. This was higher than the expected rise of 0.25% and is the largest rate increase since February. The Bank of Japan kept their ultra-low interest rates unchanged. At the European Central Bank Forum on Central Banking in Sintra, Portugal (26^th-28^th June), policy makers were keen to stress that market participants should not anticipate any interest rate cuts for at least a period of one to two years.

US Secretary of State Antony Blinken made the long-awaited trip to China on 19^th June to meet with President Xi Jinping in Beijing’s Great Hall of People (which is usually reserved for meetings with heads of state). The purpose of the trip was to attempt to ease tensions between the two countries. The initial meeting was planned for February but delayed after the US shooting of the suspected Chinese spy drone. During the meeting ‘China and the United States agreed on Monday to stabilize their intense rivalry so it does not veer into conflict, but failed to produce any major breakthrough’[i]. Both leaders of the two countries, US President Joe Biden and China’s President Xi Jinping cited the meeting as progress as concerns were able to be raised and channels of dialogue were opened. Whilst at this time, no firm plans have been put into action, the face-to-face meeting with US Secretary of State has begun a journey for the two countries to communicate further.

On 21^st June, US Federal Reserve Chair Jerome Powell testified before the House of Financial Services Committee to deliver his semi-annual report to both Chambers of Congress. The next day he appeared in front of the Senate Banking Committee. After US markets had benefited from the Federal Reserve keeping interest rates unchanged, Powell ‘hinted at the likelihood of further interest rate hikes’[ii] leading to further sell offs in US equity markets.

On 22^nd June, the Prime Minister of India, Narendra Modi, made his first official state visit to Washington D.C. to meet with President Joe Biden. The purpose of the meeting for Modi was to raise the status of India and strengthen ties with the US and ‘the two countries announced agreements on semiconductors, critical minerals, technology, space cooperation and defence cooperation and sales’[iii]. One deal that has already been signed off is with General Electric to produce jet engines in India for their military aircrafts with an agreement with Hindustan Aeronautics. Further deals are being planned between the two nations and no doubt will be a boost for the economy in India.

On the weekend of 24^th June, Yevgeny Prigozhin, the boss of private mercenary army Wagner, led an ultimately brief rebellion starting in the city of Rostov-on-Don, Russia, moving north towards Voronezh following the path towards Moscow. ‘Wagner fighters have taken control of all military facilities in the city of Veronezh, about 500km (300 miles) south of Moscow’[iv] with which Putin made an announcement accusing Wagner fighters of “treason”. After the initial ambush Prigozhin ordered his army that was advancing on Moscow to stand down to avoid any further casualties. Whilst this has been short lived the act made a large impact calling for countries to prepare a quick response if the situation was to escalate further and ending with a tougher response from Russia on its attack on Ukraine. Mr. Prigozhin was exiled to Belarus in exchange for the criminal case being dropped against the Wagner Group.

Overall, June saw mixed performance across asset classes. Brent Crude, after starting the month at levels of c.$74 per barrel, remained at a similar level throughout the month. Japanese equities have reached a 33-year high and UK 2 year Gilt yields reaching a level of over 5%.UK 10 year Gilt yields reached highs of 4.49% and US 10 year Treasury yields 3.839%. During June Sterling also hit its highest level at c.1.28 against the US Dollar over the past year and gold slightly fell in value.

[i] https://www.reuters.com/world/china/blinken-wrap-up-rare-visit-china-may-meet-xi-jinping-2023-06-18/

[ii] https://www.reuters.com/markets/us/futures-muted-ahead-powells-congressional-testimony-2023-06-21/

[iii] https://www.reuters.com/world/biden-modi-strengthen-ties-with-defense-trade-agreements-2023-06-22/

[iv] https://www.reuters.com/world/europe/how-mercenary-revolt-has-gathered-pace-russia-2023-06-24/