Markets were not happy last week

The Markets were not happy last week.

All we heard last week was interest rates and interest rates. So let’s talk about interest rates.

In the US, Federal Reserve Chairman Powell kept reiterating that the fight against inflation is not done and they will have to raise again, and in the UK, the Bank of England added another 50 basis points to the current rate taking the nation’s base rate to 5%. Still, could have been worse, the Turkish Central Bank raised from 8.5% to 15%!

In our opinion, the larger-than-expected hike was actually quite an astute move from Governor Bailey and his team at the Bank of England.

The markets took this to mean that the terminal rate now might reach 6.25% at the end of the year/early 2024, but actually, by moving quicker, we believe the BoE committee are trying to speed up the ‘pain’ so that the terminal rate can be kept lower, not higher.

The worst thing for the economy would be a higher rate for longer. This must be avoided at all costs. The impact should be more pronounced by moving quicker, with a bigger jump, just as producer prices are falling. A slightly bigger shock now, to get the desired effect. There is no reason that the longer-term rate will now be higher than previously thought – as long as the plan works.

Inflation will start to come down, and hopefully, we’ll see evidence of that next month; we certainly should given the drop in wholesale prices. We just need producers to now pass these drops on. Once we signs of disinflation, as we do in the US and Europe, the price fall will accelerate rapidly.

However, we saw no evidence of that this week, and European markets did not like the data.

In Europe this week the pan-European STOXX Europe 600 Index fell 2.93% on worries that these interest rate increases might cause a recession in Britain and the eurozone. A disappointing economic recovery in China and hawkish comments by U.S. Federal Reserve Chair Jerome Powell also contributed to the gloom. Major stock indexes struggled, with Germany’s DAX dropping 3.23%, France’s CAC 40 Index slid 3.05%, and Italy’s FTSE MIB losing 2.34%. The FTSE 100 Index declined 2.37%.

These are huge drops in relative terms.

Recession fears pushed European government bond yields lower. Purchasing manager surveys showed private sector business activity has slowed significantly, weighing on 10-year German bond yields. French, British and Swiss yields also declined.

Norway’s central bank also increased its key interest rate by 0.5 percentage point to 3.75%—the highest level since 2008—and indicated that it “will most likely” hike again in August to curb inflation that is “markedly above target.” The Swiss National Bank raised its benchmark interest rate by a quarter percentage point to 1.75%, the fifth consecutive increase, and did not rule out additional rate increases.

Eurozone business output grew for a sixth month in June but almost stalled, pointing to renewed weakness in the economy after the recovery in the early part of the year, according to purchasing managers’ survey data provided by S&P Global. The HCOB Flash Eurozone Composite Purchasing Managers’ Output Index fell to a five-month low of 50.3 from 52.8 in May. A level above 50 denotes expansion.

German producer prices rose in May at their slowest pace since July 2021, a sign that inflation may be easing. Annual producer prices climbed 1.0%, down from 4.1% in April. Meanwhile, the Ifo Institute predicted the German economy would contract 0.4% in 2023, more than the 0.1% forecast in March.

In the US, the major benchmarks closed lower in a holiday-shortened trading week. The Nasdaq Composite suffered its first weekly decline in two months, while the S&P 500 Index recorded its first drop in six weeks.

Growth stocks outperformed value shares, while large-caps fared better than small-caps.

Signs that further Federal Reserve rate hikes lay ahead seemed to weigh on sentiment for much of the week. In prepared testimony before Congress on Wednesday and Thursday, Fed Chair Jerome Powell stated that “nearly all [policymakers] expect that it will be appropriate to raise interest rates somewhat further by the end of the year.”

Indeed, the Fed’s latest Summary of Economic Predictions revealed that a majority of those on the policy committee expect at least two more quarter-point rate hikes in the coming year—although futures markets continued to predict that was unlikely. News on Thursday that the Bank of England and Norges Bank, Norway’s central bank, had accelerated their pace of rate hikes also seemed to intensify rate fears.

Much of the week’s economic data seemed to deepen worries that tight monetary policy was pushing the U.S. into recession. On Friday, S&P Global reported that its gauge of U.S. manufacturing activity had fallen back to its lowest level since December and well below consensus estimates. The report also showed that suppliers were cutting prices at the fastest pace since the heart of the pandemic lockdown in May 2020, presumably in response to weak demand.

Japan’s stock markets retreated from their 33-year highs, with the Nikkei 225 Index falling 2.7% and the broader TOPIX Index finishing the week 1.6% lower. Some of the declines were attributable to profit-taking following the markets’ strong year-to-date performance.

Chinese stocks also retreated after a holiday-shortened week as investor confidence waned over a lack of stimulus measures amid the flagging post-pandemic recovery. The Shanghai Stock Exchange Index fell 2.3%, while the blue-chip CSI 300 gave up 2.51%.

In Hong Kong, the benchmark Hang Seng Index declined 5.74%, its biggest drop in three months. Financial markets in mainland China were closed Thursday through Friday for the Dragon Boat Festival holiday, while the Hong Kong Exchange was closed on Thursday and reopened for trading on Friday.

Next week will be the last trading week of the month, quarter, and first half of the year.

Historically, whenever the S&P 500 is up at least 10% year-to-date as of the end of June, the index ended the year higher 82% of the time, gaining 7.7% on average, according to research from the Carson Group.

On Friday In the UK we will see whether house prices have continued to drop as well as last quarter’s GDP results. Hopes are that the UK economy has continued to grow, even if it is a modest 0.1%.

In the US, we’ll receive more updates on the housing market there too with April home prices and May new home sales.

On Friday, the Bureau of Economic Analysis will release the Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge.

We’ll also get consumer sentiment readings from the Conference Board and University of Michigan, and the final estimate for first-quarter gross domestic product.

Inflation and unemployment readings for the eurozone will also become available. Carnival Cruise Line, Walgreens, Micron Technology, General Mills, and Nike will report earnings next week.

Fund managers across the world will be hoping that this decline faulters and the market can start to focus on what happens after inflation.

What will be next we wonder?

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