By Jan Faure
Global equity markets made further gains in July as cooling inflation in the US, UK and Europe boosted global investor sentiment. Adding to buoyant sentiment were positive earnings results as second quarter company earnings season got underway on the US. This, coupled with encouraging US GDP data, strengthened the narrative of a soft landing in the US following eleven interest rate hikes since March 2022.
The blue-chip S&P 500 Index gained 3.1% in July while the tech-heavy Nasdaq Composite Index added 4.0% for the month. In Europe, the Euro Stoxx 50 gained 1.6% while the UK’s FTSE 100 added 2.2%. In Asia, Japan’s Nikkei 225 declined 0.1% while Hong Kong’s Hang Seng increased by 6.1%. Fixed income also recorded positive returns overall, with global investment grade bonds rallying 0.7% for the month.
US inflation data for June showed a sharp decline, offering renewed hope that the US Federal Reserve (Fed) can soon conclude the most aggressive interest-rate hiking cycle in decades. The consumer price index (CPI) rose 3% year-on-year in June from 4.0% YoY the previous month. The rapid drop in US headline inflation, since peaking in June last year, has helped stock markets remain resilient despite interest rates rising higher than many market participants had expected. However, the prospect of an extended tightening cycle (the Fed holding interest rates at current levels for longer than expected) and tightening financial conditions still fuel recession fears as yield curves remain inverted.
The Fed raised interest rates by 25 basis points in July as expected, bringing the Fed Funds Rate to 5.25-5.50%, the highest since January 2001. Chairman Jerome Powell stressed that future policy action will be data dependent, reiterating the Fed committee’s intention to, “keep policy restrictive until we’re confident that inflation is coming down sustainably to our 2% target”. The Fed will need to see clear signs of cooling inflation, especially an easing in tight labour markets, before ending the tightening cycle. Powell noted that Fed economists are no longer forecasting a recession in 2023 given the resilience of the US economy but are still anticipating a noticeable slowdown in growth later this year.
The European Central Bank (ECB) also raised rates in July, increasing the deposit rate by 25bps to 3.75%. The ECB raised the prospect of a potential pause, most likely in September, although maintained a data dependent approach much like the Fed. In the UK, inflation moderated more than expected in June, with CPI rising 7.9% YoY from 8.7% YoY in May. The slowdown was mainly due to lower energy prices. Both the ECB and BOE are behind the curve compared to the Fed and, as such, further policy action is expected in the months ahead.
Equity markets have been resilient year to date in the face of restrictive interest rates, reflecting in part the rise in soft landing expectations, largely driven by a resilient US economy – US 2Q23 GDP grew by a better than expected 2.4% YoY. Despite this, the prospect of a longer tightening cycle and tight credit conditions still fuel hard landing fears. However, if inflation can continue to moderate, and central banks can successfully navigate this challenging inflation cycle, then we believe markets will remain resilient.
Table 1: Global Indicators – Local reporting currencies
