By Jan Faure
August was tale of two halves for global markets with initial gains being erased in the second half of the month following hawkish comments by Fed Chairman Jerome Powell. In the US, the S&P 500 index declined 4.2% for the month while the tech-heavy Nasdaq fell 4.6%. European equities were weaker with the Euro Stoxx 50 index dropping 5.1% for the month. Asian equity markets were slightly better with Hong Kong’s Hang Seng index shedding 1.0% while a weaker currency helped Japan’s Nikkei 225 close in the green with a 1.0% gain.
Global markets were buoyed in the first few weeks of August on hopes that the US Federal Reserve would ease the pace of monetary tightening in the months ahead so as not to stave off economic growth entirely. This perception changed drastically at the Fed’s much-anticipated annual economic symposium at Jackson Hole where Powell dealt a blow of harsh reality to global markets.
Powell said efforts to tame inflation will require a “sustained period of below-trend growth” that will lead to “some pain” for households and businesses. It removed any doubt that the Fed will continue to press ahead with interest rate increases until it is satisfied that inflation is under control. Global equity markets immediately swung into negative territory, erasing the month’s hard-fought gains.
Put simply, US rates will rise further (beyond the neutral interest rate) and stay there for a prolonged period of time. The Fed is willing to sacrifice growth and accept rising unemployment in order to bring inflation down to targeted levels. Equities and bonds immediately sold off following Powel’s comments, with the S&P 500 index tanking 3.4% and US Treasury yields rising.
Despite the hawkish tone, there is evidence that inflation is easing, especially as commodity prices have retreated as demand has moderated amid higher prices. Supply chain constraints have also improved significantly. US headline inflation (CPI) slowed to 8.5% YoY in July from 9.1% YoY the previous month, a huge relief to markets. US core inflation, which excludes food and energy prices, was unchanged at 5.9% YoY from the previous month. Despite a drop in core inflation, a tight US labour market is keeping price pressures firmly supported.
Crude oil prices declined further in August, the third consecutive month, as concerns of a global economic slowdown overshadowed a threat by OPEC+ to cut oil supply to counter lower prices. Fresh Covid lockdowns in China also added to demand concerns. The decline has erased all gains made since Russia invaded Ukraine in February. Similarly, copper extended its losing streak to five consecutive months. Copper, widely considered an economic bellwether, has also suffered from growth concerns due to Europe’s energy crisis, tighter monetary policy and China’s zero-Covid strategy.
Table 1: Commodities– Year to Date
In China, 2022 can be described as the year of the ‘own-goal’. The country has tried various stimulus measures to offset the negative effects of its own strict Covid policies, but to no avail. It has just recently locked down around 20 million people in Chengdu to fight a fresh Covid outbreak. Adding to its troubles has been heatwaves that have put strain on the country’s electricity grid.
In Europe, headline inflation for July reached a record high of 8.9% YoY, the highest since the euro was established in 1999. Europe’s soaring inflation is being driven by record high gas and electricity prices, with no respite foreseeable in the short-term due to geopolitical headwinds that have led to structural changes in the region’s energy markets. Europe is facing a cold winter on many fronts which will challenge the block in political, social and economic ways. A recession has become increasingly likely.
The US economy is in a healthier position than its European counterparts. US manufacturing activity and employment data have held up despite rising interest rates and decade-high inflation. This strong economic backdrop has given the Fed the leeway to be aggressive in its inflation fight. August’s renewed hawkish language by the Fed has, however, brought a fresh bearish tone to global markets, and we expect the volatility experienced in the first half of the year to continue throughout the second half.
There is still a lot of scepticism over the ability of central bankers to manage this inflation cycle. Companies are having to adjust to an environment where capital is not free and inflation is elevated, and there are persistent concerns over the impact of softening demand and cost pressures on company earnings. From an investment perspective, investor appetite is transitioning from paying any price for growth to investing in companies with profitable growth.
Table 1: Global Indicators – Local reporting currencies
