As markets continue to wrestle with the current data, we continue to believe the turning point for the US Federal Reserve remains close, but the data confirms we are not there yet. Markets have been weak year to date but as we saw in mid-summer have the potential to bounce quickly if the interest rate pressure is relieved.
September represented another tough month for risk assets, as concerns about growth, inflation and rising interest rates continued to weigh on investor sentiment.
The MSCI World Equity Index slumped 5.5% during the month in Sterling terms.
The FTSE 100 held up marginally better, although still fell 5.2%.
As markets continue to wrestle with the current data, we continue to believe the turning point for the US Federal Reserve remains close, but the data confirms we are not there yet. Markets
have been weak year to date but as we saw in mid-summer have the potential to bounce quickly if the interest rate pressure is relieved.
Bonds, which are in the midst of one of their worst selloffs of the past century, continued to struggle. The US inflation print for August was much anticipated by markets but did not bring the relief many hoped. The Consumer Price Index increased by 0.1% when a 0.1% drop was expected and more interestingly the core measure, which strips out energy and food, rose by 0.6%. The market had hoped for weaker inflation data that would have enabled the US Federal Reserve to temper its interest rate increases, leaving a better chance for a softer landing for the economy. This stronger than expected data means the Fed has no reason to back off its rate hiking plan, and it subsequently increased its key Fed Funds Rate by 0.75% later in the month. The yield on the two-year US Treasury Bond reacted by rising 0.8% to 4.3%, its highest month-end reading for over 15 years, as the market priced in a faster pace of rate hikes by the Fed than had previously been expected.
UK government bonds suffered even bigger falls over the month as the market did not take kindly to the governments bold tax cut plans within its mini budget from Kwasi Kwarteng, such as 1% off basic rate tax and the abolition of a higher 45% tax rate (which was later abandoned). Critically, the budget was not accompanied by any actual figures from the Office of Budget Responsibility (OBR) to justify the tax cuts put forward. Kwarteng remains defiant that these tax cuts will ultimately reduce the national debt burden by stimulating growth, and whilst this is potentially achievable, several market commentators disagree. A joint report by the Institute for Fiscal Studies and Citi, a global investment bank, suggests that levels of borrowing are set to be £60bn a year higher than the OBR forecast in March.
At the same time the Bank of England (BoE) has said it will continue to raise interest rates to tame inflation, meaning the UK economy is currently driving with one foot on the brake and the other on the accelerator. The BoE raised its base rate by 0.5% in September after it was confirmed that the Consumer Price Index rose by 9.9% in the 12 months to August. This does represent a slight fall from the 10.1% rate recorded in July but is still the highest in the G7 and continues to apply pressure to the BoE to keep raising rates aggressively. The brighter news will be the effect of Liz Truss’s £150bn spend on limiting energy bills that is expected to cap inflation at a lower level than previously expected, however food inflation remains high at 13.4%, heading in the opposite direction to fuel inflation that has fallen from a year on year 43.7% to 32.1%.
In reaction to the mini budget, Sterling fell sharply against the US dollar, at one point hitting a record low. It was not helped by criticism of the tax plan from the IMF, which urged the Conservative Party to reconsider its tax cutting plans. UK bond yields and Sterling did recover somewhat later in the month after the BoE surprisingly stepped in to reassure markets. The UK central bank stated that it would postpone the beginning of planned bond sales and begin buying long-dated government debt in a bid to ease market dysfunction. The swift actions of the BOE did stabilize the situation, however the political damage to the Conservative party has been severe, with a YouGov poll towards the end of the month showing Labour have a huge 33 point lead over the Conservatives - the highest for almost thirty years. Sterling ended the month down 4.2% versus the dollar, with the UK 10-year government bond yield jumping from 2.8% to 4.2% during September (meaning its price fell).
Elsewhere, commodity prices were broadly weak. Lumber prices fell to their lowest level in more than two years. Demand spiked as a result of the covid pandemic building boom but is expected to fall due to a sharp slowdown in construction. Oil futures fell over 10% in USD terms. The price of a barrel of WTI Crude fell as low as $76 within the month although it made up part of its lost ground later in the month as news emerged that OPEC was considering its biggest output cut since the pandemic began. The price settled at a little below $80 by the end of the month.
Our client portfolios remain relatively defensive, but we are looking for opportunities to add exposure to US equities to ensure we capture the upside performance that will inevitably come and we are also taking tentative steps into the bond market.
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