Market updates from August
In a Nutshell
UK’s inflation is on the decline, with June prices showing a 7.9% increase compared to a year ago, down from a peak of 11.1% in October. This drop can be attributed primarily to the stabilisation of energy prices. Same behaviour from the European Central bank trying to reduce inflation to its 2% medium-term target. Over the pond in the USA, central bankers gathered at Jackson Hole to discuss monetary policy. There was a growing expectation that interest rates would remain high for an extended period. In Asia, investor optimism regarding China has diminished since the end of its Zero Covid policy in January, however, China’s central bank is attempting to tackle this by cutting interest rates to stimulate economic growth with the complex challenge for monetary policy.
UK - Bank of England reports inflation is falling but it’s still too high
In the UK, inflation has started to decline, with prices in June being 7.9% higher than a year ago, down from a peak of 11.1% in October. The primary reason for this decline is the stabilisation of energy prices, which had been steadily increasing. However, despite this improvement, inflation remains significantly above the target of 2%. [1]
Several major shocks have contributed to the high inflationary pressures in the UK:
1. Covid-19 Pandemic
During the pandemic, people shifted their spending habits from services to goods. This change in consumer behaviour created supply chain challenges, resulting in higher prices, especially for imported goods.
2. Russia's Invasion of Ukraine
This geopolitical event led to substantial increases in gas prices, which, in turn, affected the overall cost of living. Additionally, the conflict disrupted global food supplies, exacerbating food price inflation. In June, food prices were 17% higher compared to the previous year, partly due to poor harvests in other countries.
3. Labour Shortages
The pandemic led to a significant reduction in the available workforce, making it more challenging for employers to find suitable candidates for job openings. To attract workers, businesses had to offer higher wages, which, in turn, prompted some companies to raise their prices. This was particularly evident in the services sector, where labour costs constitute a substantial portion of overall expenses.
High inflation impacts everyone, but it disproportionately affects those with lower incomes who are less equipped to handle rising living costs. The central focus of policymakers is to bring inflation back down to the 2% target and maintain stability in prices to ensure the overall well-being of the population.
BoE expects inflation to fall further to around 5% by the end of 2023. High interest rates will help reduce the demand for goods and services in the economy and this will help slow the rates of inflation further. Expectation is that inflation will keep falling next year and meet BoE 2% target by early 2025.
EU
The European Central Bank (ECB) has observed a decline in inflation but believes it will remain too high for an extended period. To address this, the ECB has decided to increase its key interest rates by 25 basis points as of July 27, 2023. The interest rate on the main refinancing operations and interest rates on marginal lending facility and deposit facility were increased to 4.25%, 4.50% and 3.75% respectively, with effect from 2 August 2023. The ECB will maintain these higher rates as long as needed to bring inflation back to its 2% medium-term target. [2]
The bank will base its interest rate decisions on data, including economic and financial information, underlying inflation trends, and the effectiveness of monetary policy transmission. The ECB also expresses readiness to adjust its tools as necessary to achieve its inflation target and ensure smooth monetary policy operations.
USA - Highlights of Fed Chair Powell’s Jackson Hole speech
US markets were closely focused on the outlook for interest rates, particularly as central bankers gathered in Jackson Hole to discuss monetary policy. Market sentiment was increasingly leaning towards the expectation that interest rates would remain elevated for an extended period.[3]
Key developments included the US ten-year bond yields reaching their highest levels since 2007, with real yields exceeding 2% for the first time since 2009. Central bankers were closely monitoring economic data, as the direction of interest rates had become highly data-dependent. However, the longer-term concern revolved around whether economies might experience higher inflation due to supply constraints like labour shortages.
These longer-term dynamics were influencing central banks' assessments of the neutral rate, which is the equilibrium interest rate at which the economy can grow without generating excessive inflation. As the FED approached the end of its rate-hiking cycle and economists debated the timing of the first rate cut, attention shifted toward the neutral rate. This parameter was crucial because it had significant implications for longer-term bond yields and, consequently, the valuations of risk assets in the financial markets.
During this period, there was a notable difference in how yields were rising across the yield curve, with longer-term maturity US Treasuries experiencing more significant increases compared to the short end. Equities, especially high-growth tech stocks, faced challenges against this backdrop.
The speech by FED Chair Jay Powell at Jackson Hole generated significant anticipation. Powell highlighted the importance of the Fed's data-driven approach and its careful handling of inflation concerns. He conveyed the Fed's preparedness to increase interest rates if deemed essential and affirmed the Fed's dedication to keeping borrowing costs elevated until inflation demonstrated a clear path towards the 2% target. Powell emphasised that the Fed's policy trajectory hinged on incoming inflation data.
In addition to Jay Powell's remarks, other central bankers who had spoken during this period leaned toward the hawkish side. Their stance was based on the belief that core inflation remained above target, the labour market remained robust, and further rate hikes might be necessary to address these economic conditions.
APAC - What’s going on in China’s market?
Investor optimism about China waned after the end of its Zero Covid policy in January. Several factors have contributed to concerns: [4]
- Underperforming Stock Market: China's stock market has not met investor expectations, leading to disappointment.
- Perceived Economic Challenges: The underperformance of the Chinese stock market reflects concerns about significant economic challenges facing the country.
- Lacklustre Covid Recovery: Hopes for a robust post-Covid recovery have not materialised as expected.
Chinese economic data highlights these issues:
- In July, Chinese retail sales increased by only 2.5%, falling short of the anticipated 4.5% rise.
- Industrial production was up by 3.7% but lower than the prior month's increase, missing the forecast.
- Consumer prices in China fell by 0.3% year-on-year in July, indicating deflationary pressures.
One key concern is the property market, which plays a vital role in China's economy. Oversupply and falling house prices, along with the financial struggles of major real estate companies like Evergrande and Country Garden, are causing worry.
Additionally, youth unemployment is rising, with data indicating a level exceeding 20%, though recent data is no longer being published.
To address these challenges, China's central bank is cutting interest rates to stimulate economic growth. However, they face a dilemma, as they aim to boost growth without undermining the profitability of banks, presenting a complex challenge for monetary policy.
Despite sharing some demographic challenges with Japan and South Korea, China's enormous economy should not be underestimated. Geopolitical concerns persist, but China still holds significant long-term growth potential.
Investors can find reasons for optimism, especially in specific sectors and resilient companies. Consumer demand remains pent up, with trends like experience-based spending, health consciousness, and premiumization gaining momentum. There are also positive indicators in high-end luxury goods and the financial sector, particularly insurance.
China's rapid pace of innovation, driven by an ageing population and the transition to clean energy, presents compelling investment opportunities. Many of these opportunities align with core industries that are of strategic importance to the Chinese government.
In the long run, China is poised to remain an attractive destination for investment due to its expanding middle class, rising incomes, and ongoing technological innovation.
Looking ahead
The start of 2023 witnessed significant volatility in global markets. Nevertheless, there are encouraging signs as central banks take measures to curb inflation and manage interest rates.
However, this underscores the significance of adopting a long-term investment approach. Historically, periods of extended market turbulence have been succeeded by recoveries that benefit patient investors.
During this phase, it becomes crucial to diversify your investments, maintain an emergency cash reserve, and have a well-structured plan in place to navigate through the challenging market conditions. These strategies will help you withstand the uncertainties and challenges that may arise.
Important information:
The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation.
[1] Bank of England (August 2023). "Monetary Policy Report." https://www.bankofengland.co.uk/monetary-policy-report/2023/august-2023#:~:text=UK%20GDP%20is%20expected%20to,rate%20in%20the%20near%20term.
[2] European Central Bank (May 2023). "Economic Bulletin." https://www.ecb.europa.eu/pub/economic-bulletin/html/eb202305.en.html.
[3] LinkedIn. LinkedIn Post by Janet Mui. https://www.linkedin.com/feed/update/urn:li:activity:7100869066554322945?updateEntityUrn=urn%3Ali%3Afs_feedUpdate%3A%28V2%2Curn%3Ali%3Aactivity%3A7100869066554322945%29.
[4] Fidelity UK. "Why China's Markets Are Off the Boil." https://www.fidelity.co.uk/markets-insights/markets/markets/qa-why-chinas-markets-are-off-the-boil/.