By the end of the third quarter of 2023, the financial markets had demonstrated mixed performances across the globe. Equity markets remained relatively stable in GBP (sterling) terms, primarily influenced by a weaker UK currency.
However, the abrupt surge in bond yields and higher oil prices exerted downward pressure on equities. Despite signs of economic slowdown in major economies and indications that inflation had peaked in various regions, central banks maintained a cautious approach, signalling prolonged higher interest rates.
In the UK, the third quarter of 2023 saw positive returns, as indicated by the FTSE100 performance. However, the Purchasing Managers Index (PMI) experienced a slight decline, reaching 46.8 in September, signalling a contracting UK economy. Notably, the services PMI marked the largest decline since 2008 (excluding the period of Covid-19). The Bank of England (BoE) hinted at a potential plateau in interest rates, with no rate hike at the latest BoE meeting. This decision followed unexpectedly positive inflation numbers, with a decline to 6.7% in August 2023. This marked the lowest inflation increase in 18 months.
The Euro-Stoxx faced challenges during the quarter, resulting in a negative performance. In the Euro area, inflation rate dropped to 4.3% year-on-year in September 2023, reaching its lowest level since October 2021. Despite this, the European Central Bank (ECB) continued its trend of rate hikes, reaching a 22-year high of 4.5% on September 14th. PMI readings indicated a significant monthly decline in business activity at the end of the third quarter.
The US experienced mixed performance in the third quarter, with the S&P 500 generating a fall of 3.6% in dollar terms but positive in GBP terms. The Federal Reserve maintained the target range for the federal funds rate at a 22-year high of 5.25% to 5.5% during its September 2023 meeting, in line with market expectations. However, the Fed signalled the possibility of another rate hike later in the year. In the US, the annual inflation rate accelerated for the second consecutive month, reaching 3.7% in August 2023. Rising oil prices and base effects contributed to the increase in inflation. Additionally, the US unemployment rate rose to 3.8% in August 2023, marking its highest rate since February 2022.
The Japanese economy continued to expand in the second quarter, with a 4.8% annual growth rate. The export sector rebounded sharply due to a weak currency, boosting confidence among Japanese businesses. The annual inflation rate in Japan edged down to 3.2% in August 2023. The higher inflation pressure led the Bank of Japan (BoJ) to tweak its yield curve control (YCC) policy and increase the band in which Japanese Bonds can be traded. The BoJ Governor, Kazuo Ueda, hinted at a possible end to negative interest rates if supported by enough wage data.
The Chinese economy grew by a seasonally adjusted 0.8% in the second quarter of 2023, surpassing market expectations but slowing sharply from the previous quarter. This indicates a loss of momentum in China’s economic recovery, driven by factors such as an ongoing property downturn, the possibility of disinflation, record high youth unemployment rates, and declining exports.
While inflation remains a persistent force, it’s increasingly likely that central banks may soon conclude their interest rate hike cycle as they weigh the threat of inflation against the risk of a potential recession. This assessment suggests that, within the next 12 to 18 months, there may be signs of an economic slowdown due to the delayed impact of rising interest rates. Indeed, we see some downside risks on the horizon. The current monetary policy is notably too restrictive, particularly in places where the economy is dependent on short-term interest rates. Such economies include the UK and some European countries where there is a concern about a potential credit crunch, albeit a small one. In addition, there are signs of an impending earnings recession.
Looking ahead, there is potential for an improvement in the outlook for inflation and growth-sensitive assets. We expect that inflationary pressures will persist, but to a lesser extent, while oil prices have continued to increase in the last few months following a cut in oil production by OPEC. In light of these complex circumstances, we are actively positioning our portfolios to navigate short-term turbulence and make tactical decisions that optimise outcomes for our investors. Despite potential conflicts between bonds and equities in the short-term, we remain committed to our carefully risk-managed approach, diligently seeking opportunities while delivering the best results for our clients.
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