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Article | 05 May 2023 | Investments
After some initial disappointment over central banks’ continued hawkish stance, equity markets staged a late month recovery, buoyed by a better-than-expected start to the first quarter earnings season. European stocks were among the strongest performers, with UK shares rallying 3.1% (FTSE 100 Index) and French shares gaining 2.3% (CAC 40 Index). Japanese shares also posted solid returns (TOPIX Index +2.7%), with the Nikkei 225 Index hitting an eight month high. US equities ended the month with positive returns (S&P 500 Index +1.5%) but emerging market stocks fell (MSCI EM Index -1.3%), dragged lower by weak returns from China (MSCI China Index -5.2%).
Bond markets eked out modest gains, with corporate bonds outperforming government debt. Bonds initially rallied amid hopes that central banks would pivot to a more dovish stance, but later lost some of the gains as these hopes appeared premature. In the US, the 10 year Treasury bond returned 0.7% over the month as yields moved slightly lower. In Europe, government bond returns were mostly negative as yields rose. German Bunds held up the best, with the 10 year benchmark bond returning 0.1% over the month.
The euro strengthened against the US dollar over April as the Federal Reserve (Fed) was seen to be nearer the end of its rate hiking cycle than the European Central Bank. The British pound also rallied after higher-than-expected UK inflation boosted expectations that further UK rate increases were likely. The Japanese yen weakened further after the Bank of Japan’s new governor ruled out any changes to Japan’s ultra-accommodative monetary policy.
Oil prices jumped at the start of April after OPEC and other oil producing nations agreed to cut production, but later weakened amid concerns of softer global demand. Brent crude slid 0.3% over the month to close at $79.50 a barrel. Gold prices inched 1.1% higher to $1,990.00 a troy ounce.
Volatility declined as fears of a global banking crisis faded. Overall the Vix Index dropped 15.6% over the month to close at 15.8. A reading below 20 is widely viewed as an indicator of market stability.
Oil companies continue to report bumper profits, sparking calls for them to face higher taxes to help fund the transition to more renewable forms of energy. However, many US companies have said they will step up investment in oil and gas production, while UK oil giant BP has been criticised for its decision to slow planned cuts in fossil fuel production and carbon emissions.
Fears of a banking crisis faded, with large US and European banks announcing sizeable first quarter profits. However, US investment bank JPMorgan Chase was forced into an emergency rescue of California-based regional lender First Republic Bank after shares in the latter plummeted, when it revealed the extent of deposit withdrawals during March.
US corporate earnings topped estimates, with FactSet reporting that 80% of S&P 500 companies that had reported so far had beaten forecasts. Nevertheless, US corporate earnings as a whole are expected to decline for the second consecutive quarter between January and March.
While headline rates of inflation continued to fall, western central banks continued to be hawkish as core inflation remained sticky, dashing hopes that the banking crisis would cause them to pivot to a more dovish stance. Meanwhile, the new governor of the Bank of Japan confirmed that ultra-loose policy would be maintained.
Economic activity looks to be picking up in Europe, driven by strong growth in the services sector although manufacturing activity remains weak. However, growing evidence of a slowdown in the US economy is expected, as the sharp rises in interest rates over the last 12 months take effect.
China’s economy rebounded 4.5% in the first quarter on a year-on-year basis. However, while services activity has picked up sharply following the end of Covid-19 restrictions, the manufacturing sector has slid back into contraction territory over April, raising concerns over the sustainability of China’s growth trajectory.
Central banks face a dilemma as they balance the need to raise rates to tackle still-high inflation with the desire to avoid further distress in the banking sector. After the rate hike of early May, markets are not expecting any more rate hikes from the Fed in this cycle. However, further rate increases are expected in Europe.