By Adam Jones
Following a June in which global equity markets declined by 8%, July offered investors some welcome respite as markets rose by >7% over the month. Government bond yields trended lower, however measures of bond volatility (which indicate the extent to which prices fluctuate) remain highly elevated as market participants attempt to front-run the policy adjustments of developed market central banks. The US central bank raised interest rates by 0.75% in July and the ECB raised by 0.50%, bringing their Deposit rate back up to 0% following 8 years of negative interest rates. The Bank of England is also expected to make its next move higher on August 4th, with futures markets currently anticipating an increase of 0.5% in the base rate[i].
These moves are being made primarily in attempts to address the ongoing issue of inflation. US data once again surprised on the upside in July, with the headline inflation rate pushing to new highs of 9.1%. Similarly eye-watering figures arose both here in the UK (9.4%) and in Europe (8.9%). Part of the difficulty central banks currently face is that a large proportion of this inflation is being driven by factors that are outside of their control, such as commodity prices, ongoing supply chain issues and tight labour markets. In our view this greatly increases the probability that mistakes will be made as consumer demand falls further into what appears to be an already slowing global economy.
Major indicators of sentiment and economic activity in Europe fell to levels last seen during the pandemic and in our belief is that the Euro Area remains particularly vulnerable in terms of its dependence on imported energy. A further reduction in gas from Russia in July drove the European Union to agree to cutting gas consumption by 15%[ii], however natural gas prices in Europe remain far higher than those in other parts of the world. In the US economic activity also showed signs of deceleration as early estimates of services & manufacturing activity fell to its lowest level in two years[iii].
In China we received news that the country’s economy had contracted in Q2, due in large part to continued lockdowns in the wake of renewed pandemic fears. The government is making efforts to shore up the property market and support economic growth, however a Zero-Covid policy remains its top priority which will continue to affect the region.
July also saw the beginning of the Q2 US earnings season, which provided some useful insight into the performance of many of the world’s largest companies. Results here have been fairly mixed, however as at the end of July some 77% of the largest US companies had reported earnings that came in ahead of analyst expectations[iv]. Often seen as something of an economic bellwether, Walmart Inc declared that it expected full year profits to fall by more than 10% as customers continued to cut back on discretionary purchases amidst higher food & energy costs[v]. In stark contrast to this, however, excellent results were delivered by global payment companies such as Visa and Mastercard whose management teams suggested they are still seeing no signs of a slowdown in consumer spending.
In currency markets the US Dollar showed tentative signs of having peaked in mid-July, however the Dollar tends to perform well in an environment of slowing global growth which, at least to us, feels increasingly likely to be the case moving forward. During July we saw the Euro (very) briefly trade through parity versus its US counterpart, however the currency went on to recover marginally and close the month nearer 1.02. The British pound displayed similar dynamics, strengthening in the latter half of the month to close at 1.22 vs the Dollar. Following a period of very significant weakness the Japanese Yen posted its largest weekly gain in over 4 months, a move which could be self-reinforcing given the large number of speculative traders who are betting against the currency[vi].
In some respects July saw the return of more ‘normal’ market relationships (bond yields lower, equities higher), however we continue to believe that the distribution of potential outcomes remains wide for both markets and economies moving forward and that a focus on diversification across asset types, styles and strategies remains of critical importance.
[i] Refinitiv, CME Group SONIA Futures
[ii] EU Seeks 15% Cut in Gas Use on Russian Supply Squeeze (yahoo.com)
[iii] U.S. July flash PMI data show ‘worrying deterioration’ in economy | Morningstar
[iv] I/B/E/S Data from Refinitiv
[vi] Yen rises to two-month high as investors slash short bets | Financial Times (ft.com)
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