Global equities reversed course last week, with markets unwinding some of their recent gains. Global equities were down 2.0% and 1.4% in local currency and sterling terms respectively. Meanwhile, bond yields continued to edge higher with 10-year US Treasury yields breaking above 4% and testing the highs reached briefly last October.
The catalyst for the retreat in equities was an unexpected downgrade of the US’s debt rating by Fitch, one of the credit rating agencies. However, the rating was cut only slightly from its previous top-notch status and merely replicated the downgrade made by S&P back in 2011.
While the move should have minimal impact on either investors’ willingness or ability to buy US debt, it did focus attention on the sharp rise in the US budget deficit this year and corresponding increase in debt issuance. It also stirred up some concern over the sustainability of the recent gains in US equities given the increasing competition they face from cash and bonds now they are yielding so much more.
The rise in yields certainly poses some downside risk to equities. But the key to the outlook remains whether the US manages a soft-landing or not. Although recent data have been quite encouraging, the truth is that the jury is still out on this one.
Here in the UK, all the focus was on the Bank of England. As widely expected, it opted for a 0.25% rise in rates to 5.25%, rather than a 0.5% hike as in June. The Bank also released its latest batch of economic projections and raised its inflation forecasts while cutting its growth estimates. It still sees inflation slowing to 4.9% by the end of this year but not falling back below the 2% target until 2025. As for activity, it is forecasting growth will be a modest 0.3-0.5% this year, next year and the year after.
The Bank stuck to the line that further tightening will be required if there is evidence of more persistent inflation. With wage growth and core inflation both running at around 7% and still a major concern, rates look likely to be raised another 0.5% over coming months. This would leave them peaking at 5.75%, rather than above 6% as had been feared a few weeks ago.
In the US, there is a good chance that rates have already peaked. That said, this is still very dependent on the data and Friday’s US employment numbers were as ever a major focus. In the event, they proved a mixed bag. Payrolls rose a little less than expected but the unemployment rate edged lower and wage growth was slightly higher than forecast.
The latest numbers in the Eurozone also did little to change the perception that rates there are at or very close to a peak. After dicing with recession over the winter, GDP posted a moderate 0.3% gain in the second quarter. Meanwhile, headline inflation edged down to 5.3% in July and the core rate was unchanged at 5.5%.
Last but not least, we had Apple and Amazon release their results. Apple saw revenues down on a year earlier for the third quarter running but still managed a modest gain in earnings as a result of a strong showing from digital services. As for Amazon, it comfortably beat expectations with online sales and its profit margin both stronger than expected.
Overall, the results for tech-focused equities have beaten expectations this quarter. But given the sharp run-up in these stocks this year, this was arguably the minimum required to justify these gains and tech last week was actually the worst performing sector.
This coming week, the main centre of attention will be the US inflation data on Thursday, although the second quarter UK GDP numbers on Friday will clearly also be a focus for investors closer to home.
Rupert Thompson – Chief Economist