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- Last week was tough for the US bond market as the 10-year yield rose nearly 0.2%, and this pulled yields up across the world. This is partly because speeches from Federal Reserve (Fed) board members continue to stress the need to get inflation under control and do not give much hint of where interest rates will peak. The other driver of rising bond yields is that the US economy remains resilient: last week industrial production data was robust and jobless claims gave no indication of a weakening in the labour market. The ‘good news is bad news’ mantra remains.
- Equities fared better: world equities were up almost 3% in euro terms. The earnings season came to its rescue last week. Only 20% of companies have reported so far but the season is starting well. So far, earnings in the US are close to 6% better than forecast which is an above average out-turn. This week about 45% of companies will report, so we will have a broader picture of corporate performance. Sentiment was poor going into the results season, so it is not entirely surprising to see some strength on reassuring results.
- A week cannot go by without commenting on UK financial markets and last week was another one of further recovery for them. Chancellor Hunt’s move back towards austerity has gone down well with markets. The sterling-euro exchange rate is back to where it was before the ill-fated mini-budget as is the 10-year spread of gilts over euro area bonds. The news flow has been very good over the last couple of weeks to justify some recovery in sterling assets. However, a new Prime Minister may have different ideas. One would expect sterling assets to have some level of risk premium, so the moves we have seen are probably enough for now.
- In the euro area, we were back to looking at inflation. September’s inflation release was a little bit softer than indicated but it still shows inflation climbing in the region. Headline inflation is now 9.9% year-on-year and core inflation is running at 4.8%. Inflation keeps accelerating and the only bright spots are that the rate of acceleration is slowing and services inflation is not higher than goods inflation. Overall, it keeps the European Central Bank on its tightening tack.
- In the US, the data releases maintained the trend we have seen for a couple of months now. Industrial production was the main release last week and, as with the other data that we have seen recently, it is painting a picture of resilience. It was up 0.4% month-on-month for the third consecutive rise and on an accelerating trend. Not what you would expect to see if a recession is looming, and the world has to go through a period of goods destocking.
- The drama continues in the UK: two weeks ago, a new Chancellor was appointed; last week the Prime Minister resigned; and this week there will be a new Prime Minister. Changes over the last week have brought fiscal policy back onto the austerity path. The question is: will the new Prime Minister sign up to this, and will the current Chancellor remain in situ? In the short term, one would think the answer to these questions is yes. However, the longer-term outlook is less certain.
Chart of the week: fear in bond market at extremes
Bond yields have been on a remorseless journey upwards this year. In the euro area, the 10-year yield has risen 2.7% and, in the US, it has risen by 3.0%. In our chart of the week, the move index measures volatility in the US bond market. We have only reached these levels of volatility at extreme global stress points (the onset of the pandemic, the Great Financial Crisis, 9/11 and the second Gulf War). While we are uncertain about where inflation will peak out and at what level it will stabilise, the outlook does not look as bad as it did at those more stressful points. Increasing exposure to bond markets when fear is this high seems right.
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