While inflation and central banks’ use of monetary policy have been the main drivers of recent market volatility, Trevor Hubner, Investment Manager at MKC Invest, explains some of the other economic and geopolitical factors that are also having an impact.
August and September saw increased volatility across most asset classes. As has been the case since 2022, the issue of inflation andcentral banks’ use of monetary policy has been the main catalyst, but there are also other economic and geopolitical factors in play that need to be considered.
Inflation has proven to be far stickier than hoped and the trajectory of interest rates has reflected this with the expected peak moving both higher and further in the distance. At the start of the year markets forecast interest rates to reach their maximum in the summer with the first rate cut to follow by the end of the year, but this anticipated pivot has now been pushed back to next year.
Outlook for inflation and interest rates
Markets remain highly sensitive to this changing backdrop. In August a less optimistic US inflation figure, together with continued signs of a strong to overheating economy, saw both bond and equities reverse quite sharply. Conversely, later in the month when employment showed the first tentative signs of weakening and inflationary data was softer, the market rebounded to regain much of the earlier fall.
Most commentators now feel that the US rate hiking cycle is either over or has perhaps one more rise before the end of the year, but the question remains as to the timing of the pivot to an easing of monetary policy.
The situation in Europe is similar but made more complex by the range in the level of inflation seen throughout member states. The European Central Bank did raise rates in September, but the future guidance was less hawkish (hawk is a market term for people who think rates should go up) and again it is hoped that policy will now remain at these levels rather than move to be more constrictive.
The UK is in a slightly different place as inflation has been slower to roll over and remains elevated. However, the landscape can change rapidly and a better-than-expected inflation figure in September gave the Bank of England room to pause the hiking cycle. The degree to which sentiment has changed is quite exceptional for what is traditionally seen as a stable asset class. Just a month ago the market was predicting a terminal rate of 6% (Schroders forecast 6.5% in June) but now it is generally thought that there will be one more rise this year and that rates will peak at 5.50%.
In a better place than 12 months ago
All the above is very much data-dependant – potential tripwires include the recent rise in oil prices and the food price inflation caused by the poor wheat and cereal harvest in Canada. In summary, we are clearly in a better place than 12 months ago, but we are aware that we have seen false dawns before during this episode and therefore continue to watch the situation with caution.
The ratings agency Fitch downgraded the US credit rating in August, citing concerns over government debt and an erosion of governance as rationale. The effect on markets was relatively muted, as stated above the economy remains in surprisingly good shape, helped in no small part by the incentives introduced by the Biden administration to encourage a lower carbon economy via the Inflation Reduction Act and to re-shore the manufacture of semiconductors with the CHIPS act. These, together with the remaining excess savings from the pandemic and the enthusiasm for AI, have driven US markets higher this year.
China and the price of oil
There was a lot of optimism earlier in the year that China would benefit from a post-covid bounce similar to that seen in other countries. However, this has not been the case and in contrast to most regions, deflation and not rising prices is becoming a cause for some concern. The disappointing economic performance, together with continuing concerns about the heavily indebted property sector, has weighed on markets globally as doubts have grown about China’s ability to drive future global growth.
The Chinese Communist Party (CCP) has announced some measures to address both the problems above but to date this intervention has been somewhat underwhelming. It seems highly probable that further support will be announced with the aim of stimulating the economy at some stage, but until there is more clarity over the measures to be introduced it is likely that investors will continue to show caution over Chinese markets.
As mentioned above the price of oil has risen quite dramatically recently. The main reason for this has been the Saudi-led restriction on production targets which, together with the ongoing issues with supply caused by the Russian invasion of Ukraine, have seen the price rise from around $68 per barrel in late June to around $90 now. The concern is not only that this is inflationary, but it comes at a time when the Chinese economy is sluggish. Should the CCP be successful in stimulating growth it is probable that both the demand and the price would move upwards.
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