By Jan Faure
Global markets mostly gained in March as turmoil in the banking sector, coupled with a further cooling of inflation, raised the prospect of the Fed easing monetary policy sooner than expected. In the US, the S&P 500 index gained 3.5% while tech-heavy NASDAQ Composite added 6.7%. In Europe, the Euro Stoxx 50 index gained 1.8% while the UK’s FTSE 100 index declined by 3.1%. In Asia, Japan’s Nikkei 225 index gained 2.2% while Hong Kong’s Hang Seng index added 3.1%.
By far the most dominant story was the failure of a group of mid-sized banks in the US, which sparked a mini-banking crisis that revived dark memories of the 2008 Global Financial Crisis. Across the Atlantic, banking giant Credit Suisse, the second-largest bank in Switzerland, also collapsed and was bought by rival UBS. The two US banks (Silicon Valley Bank and Signature Bank) sent shock waves through the global financial system.
Despite quick intervention by regulators, which to date has prevented widespread contagion, the turmoil caused a rapid repricing in markets for where Fed policy will go. The US and European financial sectors were dramatically sold down, while government bonds rallied. The global aggregate bond index gained 3% in the first three months of the year, while lower bond yields provided support for growth stocks, which gained more than 15% in the first quarter.
The US Federal Reserve (Fed) increased benchmark interest rates by 25 basis points, raising the target rate to 4.75% - 5.0%, largely in line with expectations. The rate rise was the ninth in a row, taking interest rates to the highest level since 2007. The Fed’s monetary policy statement noted that recent developments in the banking sector were likely to result in tighter credit conditions and would weigh on economic activity, hiring and inflation.
The Fed’s statement was more dovish than February’s, fuelling the view that rates would peak soon, while a rate cut could be on the cards as soon as Q4 2023. Fed chair Jerome Powel stressed that the Federal Open Market Committee would evaluate its policy stance as it learns more about the impact of recent events.
US treasury yields declined as the banking crisis raised recession risks while cooling inflation lent support to the Fed easing monetary policy. US headline inflation (CPI) dropped to 6.0% year-on-year in February from 6.4% in January. Core PCE inflation, the Fed’s preferred measure of inflation, declined to 4.6% YoY in February from 4.7% in January. Notably, the Fed funds rate now exceeds core PCE inflation, indicating that monetary policy is now becoming contractionary.
European headline inflation softened more than expected in March (preliminary data) to 6.9% y-o-y from 8.5% in February. The European Central Bank (ECB) raised rates by 50 basis points, in line with expectations, as concerns over sticky inflation trumped fears of contagion risks in the banking sector. The ECB was hesitant on guidance for the monetary policy outlook, stressing its next decisions will be highly dependent on incoming data. Central banks seem united in their uncertainty.
Annual CPI inflation in the UK unexpectedly rose more than expected in February to 10.4% (forecast 9.9%) from 10.1% in January, the first increase in four months. The largest upward contributions came from restaurants and cafes, food, and clothing. The Bank of England increased its key interest rate by 25 basis points to 4.25% the following day. The UK economy narrowly avoided a technical recession in the fourth quarter of last year. GDP expanded 0.1% q-o-q in Q4 of 2022, following a 0.1% contraction in the previous quarter.
In energy markets, oil prices surged after OPEC and its allies (OPEC+) unexpectedly announced a production cut of more than 1 million barrels a day from May. The decision follows a prolonged period of price declines that has sent Brent crude to its lowest level since December 2021. On the other hand, the sharp fall in natural gas prices continued with an almost 20% drop in March (YTD: -50%), completely unwinding the price spike caused by Russia’s invasion of Ukraine, sending gas prices to their lowest level since July 2020. The decline in energy prices has helped cool headline inflation and increased the probability of the Fed pausing further rate hikes sooner.
The events of the past few weeks have shown that the aggressive monetary policy action taken over the last year is not without consequences. This is particularly the case when rates rise off extremely low levels as they have. The turmoil in the banking sector will cause central bankers to rethink how they balance raising interest rates to fight inflation with the consequences thereof.
Central banks may have to give up on their 2% inflation targets and get used to a new normal of higher-for-longer inflation. The inflationary effects of tight labour markets and geo-political risk driving reshoring (of key manufacturing in pursuit of economic self-sufficiency) are not short-term in nature. Central bankers certainly have more to consider. On the other hand, one of the benefits of higher rates is that there are now attractive opportunities in global fixed income for the first time in 15 years.
Table 1: Global Indicators – Local reporting currencies
