In this month’s update, Pacome Breton, head of portfolio management reviews the state of the markets during September and discusses the decisions to pause on interest rate rises, both in the UK and the US. He also talks about the recent rise in oil prices, and the impact this has on different markets.
Markets were largely down in September can you provide some further insight?
During September, markets worldwide exhibited a general weakness, both in developed and emerging markets. This trend was reflected in US equities, which saw a negative return just below -5%. Given the influence of the US on global indices, we saw a similar fall on aggregate across global benchmarks, such as the MSCI World.
Similar trends were observed in Europe, China, and Canada, where performance mirrored the broader negative sentiment. However, there were exceptions in the form of the UK and Japanese large companies, each outperforming for different reasons.
In Japan, the continuing weakness of the yen remained a positive factor buoying the local equity markets. In the UK, the rebound in oil prices and commodities in general favoured the FTSE 100. This index, the primary UK benchmark for large-cap stocks, houses a number of significant commodity related companies, more so compared to other regions, and so benefited from the resurgence in energy markets.
In essence, while September saw a prevailing market weakness, certain regions displayed resilience and outperformed, responding to specific economic and currency dynamics.
The fixed income market showed notable disparities among developed regions and between short and long-term bonds. In the UK, the former saw a modest decline after inflation data, released a few days earlier, turned out to be lower than expected, albeit still elevated.
This influenced the Bank of England's decision to maintain the current interest rates at 5.25%. In the US, the Federal Reserve also chose to pause, reinforcing the prevailing sentiment that short-term rates may have peaked or are on the brink of doing so on both sides of the Atlantic.
In contrast, the landscape for longer-term bonds tells a different tale, with a persistent upward trajectory of yields. This narrative gained strength, with the expectation that yields will remain elevated for an extended period, longer than initially foreseen.
The pace of adjustment proved swift and somewhat unexpected, especially considering the absence of significant related news besides the oil price increase and the ongoing downward trend in inflation across all developed regions.
Currency movements were also notable in September, with the dollar gaining value against many currencies, especially the pound and the euro. The expectation of prolonged higher interest rates in the US makes the greenback attractive to international investors, and even concerns about a sizable deficit in the US national balance sheet hasn’t dampened their interest significantly.
Do the major central banks continue to play a significant role in driving short-term movements in financial markets?
Certainly, there were noteworthy developments from the major central banks in September. Both the Federal Reserve and the Bank of England decided to put a pause on their pace of increases for the month, mirroring the Bank of Japan, which has maintained its rates unchanged since 2016. In contrast, the European Central Bank opted for an increase of 25 basis points, or 0.25%.
Although policymakers in both the UK and the US opted for a pause, the outcomes couldn't be more different. At the Fed, the members unanimously agreed to the pause. This suggests that they might solely entertain the possibility of a final increase in November, contingent upon the macroeconomic data that emerges between now and then.
For the Bank of England’s Monetary Policy Committee, the vote was very close, with five members advocating for a pause, including Governor Bailey, and four in favour of another increase. This marked the first meeting without a hike since November 2021.
The divergence in inflation trends between the UK and the US is notable, with the latter experiencing a decline for almost 12 months, while in the UK only the most recent reading significantly deviated from the peak reached in May of this year.
In its statement, the Bank of England acknowledged the likelihood of weaker GDP in the UK for the third quarter and the rest of the year compared to earlier forecasts, a crucial factor in its decision to pause the rate increase.
The major four banks are all navigating a delicate balance, striving to bring inflation sustainably back to their 2% targets while steering clear of excessively restrictive policy rates that could push economies into recession.
The verdict is still uncertain on whether they can successfully manage this challenge, and as usual the most crucial central bank for the rest of the developed world remains the US Fed.
Thus far, the Fed appears to be striking the right balance, but providing a more precise view at this moment proves challenging. Models for GDP growth over the next 12 months still show a broad range of potential outcomes.
Taking, for instance, a widely used model from the New York Fed, its current forecast for US GDP growth is an expansion of 1.1% for 2024, but the margin of error spans between -4% to +6.3%, underscoring the difficulty in making precise forecasts.
The price of oil has rebounded lately, can you elaborate on how impactful this could be?
The move in oil prices was significant news in September. Brent, one of the two major benchmarks for oil prices, surged above $90 per barrel, a level not witnessed since November last year, although still significantly below the $120 mark observed in the early stages of the Ukraine invasion.
While this undoubtedly rekindles concerns about inflation, the impact is perceived as restrained at these levels, particularly for the US consumer. The energy share of consumption from oil and related products stands at around 4%, a figure that has markedly decreased in recent decades.
However, the impact may be more pronounced in Europe, especially given the concurrent strengthening of the dollar versus the euro. Overall, at the present level and assuming stability, the impact remains limited. Should prices escalate significantly, we would reassess the implications for our portfolios.
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About this update: This update was recorded on 3rd October 2023. All figures, unless otherwise stated, relate to the month of September 2023.
Source: MacroBond, Nutmeg and Bloomberg.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.