By Jan Faure
US equity markets charged higher in June on optimism that inflation will cool sufficiently in coming months, helping prevent the Fed from over-tightening policy rates. Labour market resilience is also helping shape the narrative that the US will avoid anything worse than a shallow recession. The S&P 500 gained 6.5% in June, taking year-to-date gains to 15.9%. This performance has primarily been driven by a narrow segment of the market, a select group of large-cap technology companies. This is remarkable when considering that the equal-weighted S&P 500 index is up a modest 3.5% YTD.
In Europe, the Euro Stoxx 50 gained 4.3% (+16% YTD) while the UK’s FTSE 100 added 1.1% (+1.1% YTD). In Asia, Japan’s Nikkei 225 gained 7.5% (+27.2% YTD) while Hong Kong’s Hang Seng increased by 3.7% (-4.4% YTD). Global investment grade (high quality) bonds have been slow to recover from last year’s rout, gaining 1.4% year-to-date. A bond rally has been curtailed due to the persistent nature of inflation, which has prompted markets to anticipate higher peak interest rates, for a more prolonged period.
Commodities, which enjoyed a stellar performance last year, have been lacklustre this year with some significant declines across the energy and industrial metals sectors. On the other hand, growth stocks (specifically technology companies), which struggled last year, have emerged as this year’s best performers, while last year’s shining stars, commodities, have become this year’s laggards. These abrupt fluctuations, over a relatively brief period of time, serve as a clear reminder of the paramount importance of diversifying investment portfolios.
In June, risk sentiment was bolstered by the US Federal Reserve pausing its aggressive rate tightening campaign. This pause coincided with a noteworthy decrease in headline inflation (CPI) to 4.0% YoY in May, marking its lowest level since March 2021. Furthermore, May data revealed a 4.3% YoY increase in US wage rates, offering a glimmer of hope to consumers who have weathered 25 consecutive months of negative real wage growth.
Core measures of inflation, which exclude the more volatile food and energy components, are proving to be far more persistent. The core personal consumption expenditure (PCE) price index, the Fed’s preferred measure of inflation, declined to 4.6% YoY in May, compared to the 4.7% recorded in April. This measure has oscillated between 4.6% and 4.7% for the past five months, underscoring the enduring stability of core inflationary pressures.
In a recent address to the Senate Banking Committee, Fed Chair Jerome Powell predicted that “it will be appropriate to raise rates again this year, and perhaps twice”. However, market participants have learnt a valuable lesson from the last few years: the Fed’s forecasting track record has been very poor. The Fed has consistently underestimated inflation (and its persistent nature) and has frequently found itself trailing the curve in combating inflationary pressures. Consequently, it comes as no surprise that the market holds divergent expectations, foreseeing only one more 25 basis point rate hike this year, with the likelihood of that materialising in July.
The Bank of England (BoE) surprised markets in June by implementing a substantial 50 basis point rate hike, double what was expected. This decision was prompted by persistent inflationary pressures as the consumer price index (CPI) for May held at a high 8.7%, while core CPI unexpectedly increased from 6.8% to 7.1%. Inflation in the UK has consistently stood out as an outlier among developed economies and remains stubbornly high. As a result, the focus has swiftly shifted towards the refinancing of fixed-rate mortgages, which potentially pose a significant political challenge for the government.
In May, the headline inflation rate in Europe decelerated notably from 6.1% to 5.5%, primarily driven by the decline in energy prices. In response, the European Central Bank raised its key rate by 25 basis points to 3.5%. Surprisingly, the Eurozone’s first quarter GDP contracted 0.1% while fourth quarter 2022 GDP was revised to a 0.1% fall. This meant the Eurozone was officially pushed into a minor technical recession. The mounting pressure on households across Europe can be attributed to soaring energy and food prices, largely driven by the ongoing Russian invasion of Ukraine.
Despite taking measures to stimulate the economy, the People’s Bank of China fell short of delivering the significant policy support that markets had been hoping for. China’s initial post-Covid reopening optimism has faded, exposing an economy that faces weakening consumer sentiment, a concerning level of youth unemployment and an over-leveraged property sector. China’s consumer inflation, however, hovers slightly above 0%, signalling fragility in domestic demand and casting doubts about the overall strength of the economy. Adding to prevailing negative sentiment are the growing trade tensions with the West, driven by concerns over China’s geopolitical positioning. Collectively, these factors contribute to an uncertain economic landscape and create additional challenges for China's future growth prospects.
Table 1: Global Indicators – Local reporting currencies
