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Article | 04 August 2023 | Investments
Global equities rallied over July (MSCI World Index +3.3%). US stocks returned to favour (S&P 500 +3.1%; Nasdaq Composite +4.0%), boosted by hopes of a soft landing for the US economy. Chinese stocks surged (MSCI China +9.3%) on news the authorities will implement further stimulus measures. In contrast, European stocks rose modestly (EuroStoxx 50 +1.6%) amid signs of a further weakening in economic activity in July. Japanese stocks also lagged (TOPIX +1.5%) as the Bank of Japan tweaked its yield curve control policy to allow a greater degree of flexibility.
Global government bond yields rose over July. In the US, the 10 year Treasury bond returned -0.8% as yields retested 4.0%. While speculation grew that central banks were at or near peak rates, borrowing costs are now forecast to remain at elevated levels for longer than initially expected. Yield curves remained inverted, however the extent of the inversion lessened, indicating that a more moderate recession could be on the horizon. Corporate bonds outperformed government debt as credit spreads tightened.
The Japanese yen strengthened as the Bank of Japan indicated it would allow greater flexibility in its yield curve control policy. This move is seen as the first step in unwinding Japan’s ultra accommodative monetary policy. The US dollar weakened against the euro, with investors betting that the Fed’s latest rate hike might be its last.
Oil prices jumped 14.2% to $85.6 a barrel (Brent crude) as the demand outlook was boosted by the promise of further Chinese fiscal support. The OPEC+ nations have also announced sharp production cuts. Wheat prices were volatile as Russia ended its agreement to allow Ukraine to export its wheat via its Black Sea ports.
Volatility rose modestly over July, with the Vix Index rising 0.3% to 13.6. Nevertheless, the Vix Index remained below the 20 level which is usually viewed to be an indicator of market stability.
The northern hemisphere experienced extreme weather conditions with extended periods of record high temperatures seen in North America, Europe and China, causing the UN secretary general to warn that the era of “global boiling” has arrived. Europe experienced extremes, with the south battling wildfires, while northern areas suffered gales and torrential rain.
After the pause in June, the US Federal Reserve (Fed) raised interest rates by 25 basis points in July, taking the federal funds rate to a range of 5.25-5.50%, a 22-year high. With US inflation continuing to moderate and the Fed insisting that further hikes would be data dependent, speculation grew that US borrowing costs might now be at their peak for this cycle.
The European Central Bank also raised rates by 25 basis points in July. Policymakers signalled that any further increases were not guaranteed, but could be considered “if necessary”. Eurozone inflation eased to an annual rate of 5.3% in July, the lowest rate since January 2022.
In China, the Politburo promised further stimulus measures in an effort to boost growth. Recent economic data has signalled that the country’s rebound from the pandemic could be running out of steam, with consumer prices even teetering on the brink of deflation.
The US economy has proved to be remarkably resilient given the rapid hikes in rates seen since the start of 2022. Recent data has boosted hopes that the US can avoid a recession and will instead see a ‘soft landing’ – an outcome that would be viewed as being positive for equity markets.
China’s Politburo has pledged more fiscal support for the economy but has yet to announce any actual plans. Investors are keen to see the details of the stimulus, including whether it includes measures to bolster the housing market.
While interest rates may be at or near their peak in developed economies, in many developing markets there is growing speculation that rates could soon be cut as inflation moves back within target bands. The Brazilian central bank, for example, might cut borrowing costs as early as August.