A Game of Two Halves

Last week was very much a week of two halves. Global equities staged a sharp 5% bounce early on, only then to unwind a good part of that gain and end the week up 2% or so. The rebound from the lows touched at the end of last month was really down to two factors:

First, global equities were looking very oversold and due a bounce; they were down close to 15% from their mid-August high in local currency terms and just under 10% in sterling terms. Second, a larger than expected decline in US business confidence fuelled renewed hopes of an early ‘pivot’ by the US Fed.

This refers to when the Fed will finally stop raising rates and possibly even start talking about cutting them. Swings in sentiment about when this could happen have been behind the sharp market moves of recent months. Inflation developments are the key here, with inflation the number one focus for the Fed at the moment.

Indeed, an unexpected fall in the US unemployment rate back to its pre-pandemic low of 3.5% was the catalyst behind the market decline on Friday. Continued tightness in the labour market highlights the difficulty the Fed faces in bringing wage growth back down to more acceptable levels and the need for further rate hikes.

OPEC also did its best to halt the market rebound, announcing a larger than expected 2mn barrel per day cut in its output target. This amounts to around 2% of global supply although in reality OPEC has been producing well below target and the actual cut should be significantly smaller. The oil price is back up to $97 per barrel but remains well below the highs of around $120 touched earlier in the year.

Here in the UK, the panic set off by the mini-budget two weeks ago may be over but the hang-over is not. While the pound has recovered most of its losses, government bond yields and mortgage rates remain significantly higher, and the BOE has also just rolled out another set of support measures for the gilt market.

The government may have abandoned its plan to eliminate the top 45% tax rate but this was one of the least costly of the tax reductions announced. Major question marks remain over how the government will be able to cut spending sufficiently to ease worries about the long-term sustainability of its finances. However, all is due to be revealed by the Chancellor in his forthcoming fiscal plan which may well be brought forward from the original date of 23 November.

The market in the meantime is pricing in interest rates rising as high as 5.7% by next spring. While this looks on the high side, rates are now set to reach 4-5% as the BOE will want to offset the boost to demand and inflation coming from the government’s fiscal measures. At its next meeting on 3 November, the Bank is likely to raise rates by as much as 0.75% or possibly a full 1%.

We emphasised last week our belief that now was not the time to sell out, both because much of the bad news is now priced in and the difficulty of trying to time a market bottom. We also highlighted the prospect of continued market volatility over coming weeks.  With US inflation numbers out this Thursday, the US earnings season kicking off on Friday and key meetings of both the Fed and BOE in early November, the latter looks all but guaranteed.