INFLATION AND GLOBAL INTEREST RATE HIKES CONTINUE TO CAUSE MARKET HAVOC.
The struggle of central banks to fight multi-decade high inflation remained centre stage during the third quarter, with stock markets and bond yields responding to fluctuating interest rate expectations.
Markets in July rebounded strongly from their mid-June lows and equity exposure was reduced in the New Horizon strategies
to capitalise on the gains. By the end of the quarter, equity markets had returned to levels of the June nadir. For the year to date, the S&P 500 Index has now shed almost 24%. Recent disappointment at the US Federal Reserve’s doubling down on its hawkish interest rate stance has caused the decline in equity markets to gather pace. Developed stock markets lost between 6.5% and 10% during September alone and the S&P 500 Index registered a third successive negative quarter for the first time since the 2008 Global Financial Crisis.
Persistent Weakness
S&P 500 Index heads for longest quarterly losing streak since 2009
There was no place for traditional multi-asset investors to hide with US Treasury bond yields racing higher on three consecutive interest rate hikes of 0.75%. Consequently, many bond as well as equity indices have registered year-to-date declines of over 20% and hardly any indices produced positive returns in September.
"RECENT DISAPPOINTMENT AT THE US FEDERAL RESERVE’S DOUBLING DOWN ON ITS HAWKISH INTEREST RATE STANCE HAS CAUSED THE DECLINE IN EQUITY MARKETS TO GATHER PACE."
Year-on-year nominal returns in global government bonds (GDP-weighted ($))
The first global bond bear market in 70 years...
The US Fed set the pace for central banks around the world as developed and emerging markets came under pressure from a very strong dollar, buoyed by the steep interest rate hikes and a rush to safety.
The ongoing Russia-Ukraine war, fears of recessions setting in, and downgraded growth estimates for China also weighed on asset prices.
“THE EXTENT OF THE FINANCIAL FALLOUT FROM THE UK MINI-BUDGET ANNOUNCEMENT HIGHLIGHTS HOW PRECARIOUS INVESTOR SENTIMENT IS.”
Change of direction in UK tax policy causes further global market unease
Against this risk-off backdrop of heightened volatility and ongoing uncertainty, the third quarter ended with the UK announcing a £45bn package of tax cuts without any indication of how the shortfall in revenues would be funded. This came in addition to an energy price cap and was presented as the start of a new growth ideology.
Demand for 30-year UK gilts dried up completely, the pound reached a record low of $1.03, and the Bank of England had to step in to calm the UK market by announcing a temporary bond-buying programme.
Pound hits a record low against the dollar Dollar to Sterling rate 1971 to 2022
30 year UK government bonds
The extent of the financial fallout from the UK mini-budget announcement highlights how precarious investor sentiment is currently and gives an indication of what we could expect if a high-inflation macro-economic crisis were to escalate into a financial crisis too. Liquidity has been under pressure as developed world central banks pursue aggressive quantitative tightening programmes to reduce their multi-trillion-dollar balance sheets.
The UK events of the last week of September highlight the ramifications for financial markets when everyone heads for the doors.
The New Horizon strategies deliberately target liquidity in terms of both the selected instrument and underlying exposure which, at the very least, makes for realistic valuations even if the worst-case scenarios do transpire.
THE NEW HORIZON STRATEGIES DELIBERATELY TARGET LIQUIDITY IN TERMS OF BOTH THE SELECTED INSTRUMENT AND UNDERLYING EXPOSURE.”
Bloomberg United States Government Liquidity Index
Global Financial Stress Indicator – Market Indicator
A positive outcome of the bond market sell-off is that yields now make investment into fixed income assets an attractive alternative to cash. Risk of investment in shorter-dated issues is low. However, any addition of longer dated UK bond exposure in the New Horizon strategies is unlikely before the government outlines how its fiscal stimulus will be funded.
Meanwhile, further UK interest rate hikes are now a certainty with markets expecting a terminal rate of almost 6% for next year.
“A POSITIVE OUTCOME OF THE BOND MARKET SELL-OFF IS THAT YIELDS NOW MAKE INVESTMENT INTO FIXED INCOME ASSETS AN ATTRACTIVE ALTERNATIVE TO CASH.”
Mandatory Scary UK Bonds Chart
30-year gilts have surged to a 5% yield, for the first time in two decades
Expectations for UK base interest rates
While the UK drew attention away from the rest of the world’s macroeconomic woes for a few days, the third quarter ended with investors wondering whether the final quarter of the year will be more of the same sticky global inflation and more rate hikes— or whether hope remains that central banks might pivot away from their hawkish stance or at least pause their rising rate cycle.
During the third quarter, there were signs that inflation may be peaking. The US inflation rate fell slightly. Investor fortunes will therefore largely depend on what the inflation evidence looks like on a month-by-month basis going into the end of the year,and whether the central banks continue to see rate hikes as an effective means of reducing inflation towards their target. The UK market volatility of recent days has already allowed for the repurchase at a lower level of New Horizon equity exposure liquidated in August. Any weakening of central bank resolve could precipitate further opportunities in depressed assets and a repeat of the July rally.
“DURING THE THIRD QUARTER, THERE WERE SIGNS THAT INFLATION MAY BE PEAKING.”
GLOBAL MARKET RETURNS - Q3 2022
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