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Markets last week
Summary
Central bank decisions, corporate earnings, and geopolitical events were key market drivers last week
Equity markets ended lower overall, with notable underperformance in Europe, Japan, and the technology sector
The UK, Emerging Markets, and non-tech US equities were relatively resilient, with defensive sectors performing well
The Bank of England (BoE) cut rates by 0.25% to 5.0%, a decision narrowly passed by a 5-4 vote, marking the first rate cut since 2020
The Federal Reserve (Fed) kept rates unchanged but hinted at potential cuts soon
Economic data from Europe and the US were weaker than expected, leading to increased market volatility
US employment data showed a rise in the unemployment rate to 4.3%, with disappointing job growth
German gross domestic product (GDP) growth contracted in Q2, with higher inflation and worse-than-expected employment data
European equities declined by -4.6% in euro terms amid weak economic data and disappointing earnings
The VIX index jumped to 29.2, its highest level since March 2023, indicating increased market volatility
The BoE's rate cut led to a positive reaction in bond markets, with yields, particularly for shorter maturities, falling
The Bank of Japan (BoJ) raised rates and reduced bond purchases, only the second hike in 17 years, as inflation and wage growth picked up
The yen strengthened 4.9% against the US dollar as the carry trade continued to unwind
Japanese equities faced challenges, falling -6.0% in local terms, due to the strengthening yen and the market's exposure to the tech and the semi-conductor value chain
Geopolitical tensions in the Middle East rose following Israeli actions against key figures in Hezbollah and Hamas, with potential for retaliation and diplomatic efforts hanging in the balance.
Markets last week
Market environment
There was a lot to occupy analysts last week with major central bank decisions, corporate earnings updates, new insights into inflation and economic health as well as geopolitical tribulations in Latin America and the Middle East.
Equity markets ended lower, with Europe, Japan and the technology sector performing poorly. The UK, Emerging Markets and the US (outside of tech) held up well with defensive sectors (consumer staples, health care and communication services) and more interest rate sensitive sectors (real estate, utilities) rising. Amid earnings season corporate fundamentals played a key role in determining individual stock performance, leading to a high degree of dispersion.
It was a coin toss whether the BoE were going to cut rates from their 16-year high. The Monetary Policy Committee voted 5-4 to cut by 0.25% with Governor Andrew Bailey casting the deciding vote. This marked the first time since 2020 that the BoE has cut rates. The Fed kept rates on hold but hinted at cuts around the corner. Economic data, particularly in Europe and the US, surprised to the downside. These factors led to volatility in equities but strong performance from bonds with yields falling, particularly shorter maturities, resulting in steeper curves.
Economic insights and equities
Equity markets experienced a difficult week although there was plenty of dispersion. The rotation into smaller companies lost momentum as weak economic data in Europe and the US led to fears surrounding the potential for a more significant economic slowdown.
In the US, the decision by the Fed to leave interest rates unchanged added to recessionary concerns. On Friday, the US employment report was weaker than anticipated; unemployment rose to 4.3% and job growth was poor. Leading economic indicators remain robust but the negative momentum in economic data in recent weeks has led to rising concerns amongst investors.
In Germany GDP growth in the second quarter slipped into negative territory, unemployment data was worse than anticipated and inflation ticked higher. Peripheral European economies are outperforming core Europe with Germany the area of most significant weakness. With this backdrop European equities slipped -4.6% in euro terms.
This risk off sentiment saw a spike in the VIX index of implied volatility, a measure of uncertainty. The VIX rose to 29.2, the highest level since the US regional banking crisis in March 2023.
The expensive technology sector was the worst performing part of the marketas companies that have reported so far have generally not met the high expectations that would justify their elevated valuations. More defensive sectors such as consumer staples and healthcare performed well. Earnings in defensive sectors have beaten more conservative expectations and these sectors are trading at significantly cheaper multiples.
Bank of England
The BoE has cut interest rates from a 16 year high, swap markets had put the possibility of a cut on a knife edge. The decision reflects the central bank’s response to economic conditions and inflation with inflationary pressures having eased considerably in recent months. Headline inflation has fallen to 2% year-on-year, in-line with central bank targets.
There is uncertainty around the scale and pace of the easing cycle given the stickiness of underlying components of inflation; wage growth and services inflation remain elevated. The base effects are also set to become less favourable, and year-on-year inflation is anticipated to tick higher for the remainder of this year.
This could mean that the BoE is ‘one-and-done’ for the time being. Although further easing is anticipated, more evidence of disinflation in areas where inflationary pressures persist will be necessary to facilitate such cuts. The BoE will be data dependent, but markets currently forecast a second cut in the November meeting.
Bond markets reacted positively to the interest rate decision with yields falling sharply. Shorter maturity yields fell the most with the two-year and five-year yields falling to the lowest levels since May 2023.
Federal Reserve
The Fed left rates unchanged as expected. Chairman Powell hinted at incoming cuts with the next meeting taking place in September. The forces are aligning for the Fed to cut with progress on disinflation accelerating in recent months. The clear softening of the labour market and the slowdown in consumer spending all tip the scales in favour of policy easing. US Treasury yields fell sharply over the week and the yield curve steepened in anticipation of a rate cut in September, driven by short-dated bond yields falling more than longer-dated bond yields.
There is no Federal Open Market Committee meeting in August as the Fed heads to Jackson Hole, Wyoming, for the annual Economic Policy Symposium. Jerome Powell is expected to more explicitly guide towards policy easing in September.
Bank of Japan
The BoJ took further steps towards policy normalisation by hiking rates and committing to halve their bond purchases. The hike is only the second time the BoJ has increased rates in 17 years with the first only a few months ago. This comes as inflation and wage growth in Japan have finally picked up, aligning with the BoJ’s long-term objectives.
These measures supported the yen, increasing the momentum behind the recent reversal in the currency’s weakness. The yen strengthened 4.9% against the US dollar as carry trades - which rely on low interest rates in Japan – unwound. The yen’s recent rally has been bolstered by its status as a defensive currency amid heightened risk aversion from a selloff in equity markets.
While corporate governance reforms, as well as a weak currency, have been fuelling Japanese companies in recent years it also caught the Artificial Intelligence (AI) wave. The Japanese equity market has a large tech sector at around 15%, as well as 25% in industrials – with many of the constituents across both sectors involved in the semiconductor value chain. Therefore, it has recently been heavily correlated with the fortunes of large cap tech compounding the difficulties Japanese equities have faced in recent weeks. The Japanese equity market fell -6.0% in local currency terms but in sterling terms fell only 0.9%.
Geopolitics
Tensions in the Middle East grew increasingly elevated following recent targeted assassinations by Israel of key figures associated with Hezbollah and Hamas. The deaths of Fouad Shukr, a senior Hezbollah operative, and Ismail Haniyeh, the political leader of Hamas, have sparked concerns of retaliation.
Iran backed Hezbollah has responded with a barrage of rocket fire aimed at Israel but senior officials in the US and Israel have stated that a more escalatory response from Iran and its proxies is likely. Despite this, there is cautious optimism that the situation could be contained and that significant civilian casualties may be avoided, which could pave the way for diplomatic efforts.
The coming weeks are critical, as they will likely determine whether the region heads towards further conflict or moves towards peace negotiations. US political considerations might influence the potential for de-escalation, as international actors look for a resolution. The situation remains fluid, and developments in this period will be pivotal for the region's future stability.
The week ahead
Friday: Chinese inflation
Our thoughts: The Chinese economy has been in the doldrums since the pandemic and deflation has been a persistent thorn in the side of the country’s economy. Producer Price Inflation is expected to remain in deflationary territory in July with economists predicting price declines of -0.9% year-on-year. Some improvement is expected in consumer prices which are anticipated to have risen 0.3% year-on-year in July.
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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity. Where investment is made in currencies other than the investor’s base currency, the value of those investments, and any income from them, will be affected by movements in exchange rates. This effect may be unfavourable as well as favourable. Past performance and future forecasts figures are not a reliable indicator of future results.
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