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Article | 05 September 2022 | Investments
Equity markets slumped (MSCI World Index -4.3%) as hopes that the pace of future rate hikes might slow were dashed by hawkish central bank statements. US stocks fell 4.2% (S&P 500 Index) while European stocks dropped 5.1% (EuroStoxx 50 Index). In general, stock markets in Asia, where inflationary pressures are lower, held up better. Japan gained 1.2% (TOPIX), although mainland Chinese equities declined (CSI 300 Index -2.2%) amid worries over the impact of the nation’s zero-Covid policy.
Bonds sold off sharply on growing evidence that central banks would continue to implement aggressive rate hikes to smother inflation. European government bonds were among the worst performers. The 10-year German Bund lost 5.6% as eurozone inflation accelerated to 9.1% in August, while UK Gilts tumbled even more after UK inflation hit a 40-year high of 10.1% in July. In the US, the 10-year Treasury bond fell 3.9% and the yield curve became more inverted – such an occurrence usually heralds a recession.
The US dollar continued to strengthen, supported by the Federal Reserve’s hawkish stance on interest rates. The British pound weakened sharply, suffering its worst month since 2016 in the aftermath of the Brexit referendum, as the Bank of England predicted that the UK was likely to fall into an extended recession later this year.
European gas prices surged to fresh record highs as Russia announced maintenance-related closures of its Nord Stream 1 pipeline, further disrupting Europe’s efforts to fill gas storage ahead of the winter. In contrast, oil prices declined, with Brent crude falling 12.3% to $96.5 a barrel, on anticipation that demand would be curtailed by slowing global growth.
Volatility initially declined, with the Vix index falling below its long-run average of 20 for the first time since April, before rising again over the second half of August. Overall, the Vix index increased 21.3% over the month to close at 25.9.
President Joe Biden’s Inflation Reduction Act became the first comprehensive climate law in US history. The $740bn bill contains plans to invest nearly $375bn over the next decade in climate change-fighting strategies, including investments in renewable energy production and tax rebates for consumers to buy new or used electric vehicles.
Central banks in the west moved to dispel growing speculation that slowing economic activity and signs that US inflation may have peaked could reduce the need for aggressive monetary policy tightening. Federal Reserve chair Jay Powell stressed the US central bank “must keep at it until the job is done” by raising interest rates to combat inflation.
China struggled to contain broad-based Covid outbreaks, as it stuck to its strict zero-Covid policy. The People’s Bank of China cut borrowing costs as economic data revealed that growth remains weak in the face of sporadic lockdowns, the ongoing property crisis and a severe drought which has led to power cuts.
Geopolitical tensions between the US and China were heightened by House of Representative Speaker Nancy Pelosi’s visit to Taiwan. China accused the US of violating its “one China” policy and escalated its military exercises in the region, raising fears it would annex the self-governed island by force.
The European Central Bank’s (ECB) next policy meeting is in early September. The ECB is widely expected to raise rates by another 50 basis points, but a more aggressive rate hike is a possibility given rising inflationary pressures across the eurozone.
US economic data will be closely watched for further evidence that inflationary pressures might be easing in the world’s largest economy. US headline inflation eased to an annual rate of 8.5% in July, from 9.1% in June, while factory gate prices fell 0.5% in July, the first monthly decline since the start of the pandemic.
Europe’s energy crisis is set to remain concerning. The EU is preparing emergency measures to lower power prices by decoupling electricity prices from natural gas. Meanwhile multiple member states have called for the bloc to implement a price cap.