Global equities reversed course last week, falling 2.6% in local currency terms to be down 4.5% on their end-July high. A further retreat in the pound against the dollar to $1.22 reduced in sterling terms the decline over the week to 1.6% and from the July high to 1.1%. Sterling is now down close to 7% from its summer peak of $1.31.
For the second week running, the UK was one of the best performers, slipping only 0.4%, while the US was one of the worst with a 1.9% decline in sterling terms. China took top place for a change, eking out a 0.4% gain.
The UK also fared well in fixed income land. Whereas 10-year US Treasury yields rose further, touching a new high of 4.5%, 10-year UK Gilt yields retreated a little to 4.25%, leaving Gilts returning 0.5% over the week.
The reason behind the outperformance of UK equities and bonds was of course the August UK inflation numbers and the subsequent decision by the BOE to hold off on another rate hike.
UK inflation had been widely expected to rise. Instead, in a reminder of how difficult it is to predict both the short and long-term path of inflation, it fell. The headline rate edged down to 6.7% from 6.6% while the more important core measure slowed significantly to 6.2% from 6.9%. Rishi Sunak’s pledge to halve inflation by year-end is once again looking easily achievable.
A rate rise had been hanging in the balance but in the event, in a close 5-4 vote, the MPC left rates unchanged at 5.25%. The encouraging inflation numbers undoubtedly played a role but so too probably did the latest business confidence numbers. Optimism weakened further in September and, as in Europe, is now firmly in recessionary territory, suggesting the economy will at best stagnate over coming months.
Even so, the BOE left its forward guidance unchanged, reiterating that it would tighten further on evidence of more persistent inflation pressures. The market now believes that rates have most likely peaked but has heeded the Bank’s warnings that rates will have to stay high for some time and is wisely not expecting any reduction in rates before next summer.
The Fed also left rates unchanged at 5.25-5.5% but this came as no surprise to anyone. Like the BOE and indeed the ECB, the Fed has a hawkish bias. It retained its projection for one more hike later this year while scaling back the reduction in rates pencilled in for next year to 0.5% from 1.0%.
This confirmation that rates were set to remain higher for longer, along with news that jobless claims had fallen unexpectedly to their lowest level since January, was the main factor behind last week’s rise in Treasury yields and fall in equities.
The Fed left its inflation forecasts broadly unchanged and sees core inflation easing to 2.6% by end-2024 and falling further back towards target in 2025. But it revised up its growth forecasts for this year and next to 1.5-2%, seemingly now believing in the much-fabled soft landing.
In essence, the Fed, ECB and BOE are all now singing from the same hymn sheet: rates have most likely peaked but it will depend on the data and a further increase cannot be ruled out, with no easing in prospect any time soon.
Elsewhere, it is a different story. The BOJ left policy unchanged last week and looks certain to take further steps to exit its super easy monetary policy over coming months. Emerging markets, by contrast, are already beginning to ease rates. Brazil has lowered rates by a further 0.5% and while China made no policy change at its latest meeting, further modest cuts are in prospect there.
Turkey, it has to be said, has just jacked up rates from 25% to 30% as part of a long overdue attempt to deal with rampant inflation but this is very much the exception. The monetary easing now generally underway is one reason, along with much cheaper valuations, why we believe Asia and emerging market equities are considerably more attractive than US equities.
Rupert Thompson – Chief Economist