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Article | 06 April 2023 | Investments
It was a volatile month for equity markets. Share prices fell sharply as the failure of two US regional banks and enforced merger of Credit Suisse and UBS knocked confidence in the stability of the global banking system. But as the uncertainty faded, shares recouped their earlier losses, with many markets closing the month with modest gains amid a growing belief that central banks would be forced to adopt a more dovish stance. US shares were among the best performers (S&P 500 Index +3.5%, Nasdaq Index +6.7%) as growth-focused companies surged, boosted by hopes that any further increases in interest rates would be modest. While the Eurostoxx 50 Index gained 1.8% over March, UK shares lost 3.1% (FTSE 100 Index) as the UK market’s significant weighting to banks depressed returns. Elsewhere, emerging market stocks (MSCI EM Index) rose 2.7%, led by a 4.5% rally in the MSCI China Index.
It was a volatile month for bond markets too. Initially bonds sold off, spooked by central banks’ hawkish rhetoric, before rallying sharply as the problems in the banking sector led to speculation that central banks would be more reticent in raising rates. In the US, the 10 year Treasury bond returned 3.9% in March while the 10 year German Bund rose 3.0%. Credit markets lagged sovereign bonds as credit spreads widened sharply, with investors favouring lower risk assets given the uncertain environment. High yield debt was particularly weak as investors shunned riskier assets.
The US dollar weakened over March amid growing speculation that the US Federal Reserve was closing in on its terminal interest rate for this rate hiking cycle. In contrast, the Japanese yen was supported by its status as a safe haven asset during times of uncertainty, while higher-than-expected UK inflation (and a reduced risk of recession) boosted the British pound. The euro also gained against the dollar, boosted by stronger-than-expected economic data.
Oil prices slid over March, with Brent crude falling 4.9% to $79.80 a barrel. Natural gas prices also continued to ease. Meanwhile, gold jumped 7.8% to $1,969.30 a troy ounce. The precious metal is often seen as a safe haven during times of financial market stress, while a weaker tone to the US dollar is also beneficial for precious metals.
Volatility rose sharply as news of the failure of the two US banks broke, with the Vix Index touching a four year high of almost 29.0 mid-month. However, as central banks acted swiftly to allay fears of a full-blown banking crisis, volatility declined once more. Overall the Vix Index dropped 9.7% over the month to close at 18.7. A reading below 20 is widely viewed as an indicator of market stability.
The EU acted to avoid a mass exodus of investment in green technology to the US. In a change to previous policies on state subsidies, member states will now be allowed to match the attractive incentives offered by the US Inflation Reduction Act, opening the door for a surge of investment into the production of solar panels, batteries, wind turbines, electrolysers and heat pumps.
Financial markets were rocked by the collapse of two niche US lenders: crypto-focused Signature Bank and SVB Financial, the bank of choice for California-based start ups. As central banks rushed to reassure depositors that the banking system was sound, Swiss investment bank Credit Suisse was forced into an emergency merger with rival UBS to avoid the contagion spreading within Europe.
Despite stress in the financial sector, central banks continued to issue hawkish statements, with many tightening monetary policy. The US Federal Reserve, European Central Bank, Bank of England and Swiss National Bank were among those that raised rates in March.
Headline inflation continued to decelerate. The US inflation rate fell to 6% in February, the lowest level since September 2021, while the preliminary reading of eurozone inflation reached a one year low of 6.9% in March. However, core inflation in the eurozone proved stickier, rising to a record high of 5.7%.
With rising interest rates blamed for the failure of SVB, central banks now face a dilemma: do they prioritise bringing inflation back to target (which implies keeping rates higher for longer) or do they become more dovish to help restore confidence in the stability of the global banking system?
The problems in the banking sector have caused credit conditions to tighten, with some commentators suggesting that this is the equivalent of a 25 basis point interest rate increase. Traders are now expecting US rates will start to be cut in the second half of 2023, but much depends on the strength of the US economy, particularly the jobs market.
Headline inflation rates should start to plummet during the second quarter as the surge in commodity prices caused by Russia’s invasion of Ukraine falls out of the one year data. The key question is whether core inflation will also start to decline, or whether inflation expectations have now become embedded in wage growth.