It was another torrid week for equities with global markets following up on the previous week’s 3.7% drop in local currency terms with a further 5.4% decline.
Global equities are now down a bit over 20% from their January high and so are officially into bear market territory. UK investors have escaped some of this pain as the drop in the pound has limited the fall in sterling terms to 14%.
In short, markets have taken fright at the increasingly aggressive action being taken by central banks to deal with the surge in inflation which continues to surprise in its severity. First off the mark was the US Fed which stepped up its pace of tightening further, raising rates by 0.75% to 1.5-1.75%. This compares with hikes of 0.25% in March and 0.5% in May.
The move followed hard on the heels of the higher-than-expected inflation numbers for May and was accompanied by the Fed stating ‘it is strongly committed to returning inflation to its 2% objective’. The significance here is that the Fed is now very much prioritising getting inflation back under control rather than the other half of its dual mandate which is to maximise employment.
Chair Powell said another hike of 0.5-0.75% was on the cards for July and the Fed is now forecasting rates to be up to 3.4% by year-end, a massive change from all of six months ago when it expected rates to be only at 1%.
This more aggressive tightening has led to the Fed cutting its growth forecasts. However, unlike the market which is increasingly fearful on this front, it still does not believe a recession need be the price to pay for returning inflation back close to target in two years’ time.
Meanwhile, the Bank of England raised rates by a further 0.25% to 1.25%, while turning more hawkish on the prospect for further tightening. Its mantra changed from ‘further tightening over coming months may be appropriate’ to ‘it will if necessary act forcefully in response to indicators of more persistent inflationary pressures’.
The Bank now sees UK inflation peaking as high as 11% in October and a 0.5% rate hike in August is now looking likely with rates peaking at around 2-2.5% early next year.
Elsewhere in a surprise move, the Swiss National Bank raised rates by 0.5% although this still left them in negative territory. It was left to the Bank of Japan to buck the tightening bandwagon. It will continue with QE aimed at capping 10-year government bond yields at 0.25% despite the sharp decline in the yen the policy has caused.
Finally, the European Central Bank called an emergency meeting to deal with the fall-out from its recent move to speed up its tightening plans. In response to a sharp rise in the borrowing costs of countries such as Italy and in an attempt to forestall a new sovereign debt crisis, it announced plans to create an ‘anti-fragmentation instrument’. It will also apply flexibility in the way it reinvests maturing bonds bought under its recent QE programme.
If all of the above was not enough to shatter investor nerves, a renewed surge in European gas prices dealt another blow. Russia announced it will be reducing gas exports to Europe, just as liquified natural gas imports from the US are being disrupted by problems at a US plant.
The sell-off in digital cryptocurrencies continued this weekend as investors digest the end of the free money era. Bitcoin collapsed over 20% last week – falling as low as $17,628 – and is now down over 50% on the year.
Equities suffered most last week from the maelstrom of rate hikes but bond yields also rose further, causing some additional losses. While market volatility looks certain to continue for some while yet, we do believe the bulk of the losses in both bonds and equities should now be behind us – assuming a full-blown recession is avoided.
Rupert Thompson – Investment Strategist