Global markets were volatile in the month as generally hawkish comments from the US Federal Reserve (Fed) and panic in the banking sector following the collapse of Silicon Valley Bank (SVB) sparked a sizeable sell-off towards the middle of March. The SVB collapse was the largest bank failure since 2008 and the second largest in US history after the Washington Mutual Failure in that same year. While the Fed stepped in quickly to assure depositors that they will be made whole – and put in place a short-term liquidity facility for lenders in temporary trouble – investors began looking at other strained banks globally for signs of further cracks. Intervention from Swiss authorities saw UBS purchase the embattled Credit Suisse, resulting in some calm returning to the global banking space as the month came to an end.
The Fed’s Open Market Committee increased its target rate by 25 basis points (bps). Chair Jerome Powell emphasised that inflation remains policymakers’ top concern, noting that further tightening may still be on the cards, despite concerns over financial stability following the collapse of SVB. Powell made it clear that officials don’t expect to cut rates this year. The dot plot is signalling higher rates this year with cuts expected next year and in 2025. This is out of keeping with the futures markets – which are pointing to Fed cuts this year (maybe to counter a recession). Regulatory controls are expected to become more stringent among small to mid-sized banks, which will result in tighter lending standards and credit availability. This will be supportive of an economic cooldown, in line with the Fed’s agenda. Easing fears around a broader banking crisis contributed to a steady recovery in the S&P 500 (+1.6% towards month end). This was driven by a strong performance from interest rate-sensitive sectors, particularly tech companies - with the S&P 500 Info Tech Index rallying around 9%.
European banking shares were not immune to banking fears with Credit Suisse coming into the spotlight as the struggling Swiss lender failed to convince the market that its collapse was not imminent. Fortunately, UBS agreed to buy Credit Suisse in an all-share deal for ~$3.25 billion, which was brokered by government as a crisis of confidence in banks threatened to upend financial markets globally. The European Central Bank (ECB) pushed through another 50bps rate hike (core inflation continues to trend upwards), despite the banking chaos, citing that the euro area banking sector remains resilient, with strong capital and liquidity positions. The ECB is, however, monitoring current market conditions closely, and is ready to take action to maintain financial stability in the region. The Euro STOXX 600 bounced off its lows but ended the month down ~1.2% (Euro STOXX 50: +0.6%).
Economic Data Review
The US banking crisis has begun to ebb with the Fed remaining focused on taming inflation
Flash estimates showed that the S&P Global Composite Purchasing Managers’ Index (PMI) for the US increased to 53.3 in March 2023, from a final reading of 50.1 a month before. It was the fastest pace of expansion in private-sector activity since May 2022, as growth for the services sector offset a slower decline for manufacturers. Retail sales for February increased 5.4% year-on-year, better than expectations (4.3%). In January, the trade deficit widened to $68.3 billion, compared to forecasts of $68.9 billion, as exports grew more than imports. The unemployment rate in January edged to 3.6%, above market expectations of 3.4%. Annual inflation slowed to 6%, the lowest since September 2021, in line with market forecasts. The Fed raised the fed funds rate by 25bps in March 2023, matching the February increase, and pushing borrowing costs to new post-2007 highs, as inflation remained elevated. The decision was in line with expectations. The Fed noted the US banking system is sound and resilient, and recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation.
The ECB remains hawkish to tackle stubbornly high inflation levels
On a preliminary basis, the S&P Global Eurozone Composite PMI increased to 54.1 in March, compared to 52 a month before. This was above expectations of 51.9. Retail sales in January were down 2.3% year-on-year, compared to forecasts of a 1.8% decline. A trade deficit of €30.6 billion was recorded in January, compared to forecasts of a $28.5 billion deficit, as imports climbed 9.7% year-on-year, while exports rose 11% year-on-year. The unemployment rate stood at 6.7%, above market estimates of 6.6%. Consumer price inflation for February came in at 8.5%, slowing from 8.6% a month before. The ECB raised interest rates by 50bps in March, as expected, to help temper the region’s stubbornly high inflation. Policymakers also said the euro area banking sector was resilient, with strong capital and liquidity positions, and that they were monitoring current market tensions closely, while they stood ready to respond as necessary to preserve price stability and maintain financial stability in the region.
United Kingdom inflation unexpectedly edged higher but is anticipated to trend downwards over the year
Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 48 in March, below market expectations of 49.8. Retail sales volumes decreased 3.6% year-on-year in February, compared to forecasts of a 4.7% drop. In December, the trade deficit narrowed to £5.86 billion as imports fell 6.3% and exports slumped 5.1%. Below market expectations, the unemployment rate was unchanged at 3.7%. Annual inflation in the UK unexpectedly edged higher to 10.4% in February. The Bank of England raised its key bank rate by 25bps during the March 2023 meeting, in line with expectations. The BoE confirmed that inflation is still likely to fall sharply this year and to a lower rate than anticipated in February, but policymakers warned that if there were to be evidence of more persistent pressures, further tightening would be required. On the recent banking crisis, the central bank noted that the UK banking system maintains robust capital and strong liquidity positions and remains resilient. Policymakers will also continue to monitor closely any effects on the credit conditions faced by households and businesses, and hence the impact on the macroeconomic and inflation outlook.
Data out of China continued to gain momentum following the reopening of the economy in January
China’s composite PMI rose to 54.2 in February, from 51.1 a month before. It was the second successive period of growth in private sector activity that was the strongest since last June, buoyed by the removal of tough pandemic measures. Retail sales expanded 3.5% year-on-year in January-February, matching market consensus. Better than market forecasts, the country’s trade surplus increased to $116.88 billion in January-February, compared to $81.8 billion over the same period a year ago, as exports and imports fell 6.8% and 10.2% respectively. The surveyed urban unemployment edged to 5.6% in February. Chinese inflation fell to 1% in February, missing market forecasts of 1.9%. This was the weakest print since February 2022, with prices of both food and non-food easing sharply, as consumers stayed cautious despite the removal of the zero-Covid policy.
Inflation in Japan dropped to its lowest level since September, however, policymakers remain vigilant
Early estimates showed that the Jibun Bank Composite PMI reading in March increased to 51.9. This was the third straight month of growth in private sector output and the steepest pace since June 2022. Retail sales for January increased 6.3% year-on-year, exceeding the market consensus of a 4% gain. Japan’s trade deficit widened to ¥897.7 billion in February, compared to ¥711.5 billion in the same month a year ago, and better than the estimated gap of ¥1.1 trillion. The unemployment rate was unexpectedly lower at 2.4%, compared to forecasts of 2.5%. Annual inflation fell to 3.3% in February, in line with consensus (3.3%). The latest figure also marked the lowest print since last September, as the cost of transport rose the least in five months, while prices of fuel, light, and water charges dropped for the first time since May 2021. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations. Policymakers indicated their concerns over the economy by lowering their views on exports and production while leaving the overall economic assessment unchanged. The BoJ reiterated it would take extra easing measures if needed while expecting short and long-term policy interest rates to stay at their present or lower levels.
Outlook
Global
- Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as fiscal and monetary policy, particularly in the US, will likely be on a restrictive path. In particular, the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns.
- Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. This, combined with lower savings rates, subsiding government transfer payments, and depressed real disposable income will likely erode demand.
- At the moment, households will likely continue utilising various credit instruments, particularly credit card debt, which is currently at all-time highs, to prop up short-term expenditure prospects.
- While the Fed intends to tighten financial conditions heading into 2023, nearly two-thirds of their balance sheet reduction has been reversed since the beginning of quantitative tightening in order to stabilise the banking sector. This took place in just two weeks.
- However, the loosening of financial conditions in recent months will likely embolden the Fed to be on a restrictive path as we progress into the year as tightening financial conditions will be needed to bring inflation down to more sustainable levels. Similar sentiments will likely be shared by the Bank of England and almost certainly the eurozone central bank, which is currently grappling with all-time high core inflation.
- Chinese economic and mobility data continues to improve, and monetary policy remains on an accommodative path. It is encouraging to see China gradually re-open and Covid-19 cases well off their peak. While we remain cautious of further haphazard policy pronouncements, we are constructive on the outlook for China.
- Once peak hawkishness of the Fed has been sufficiently priced in by market participants, and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the bond curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. At this stage, we believe that the rate cutting cycle priced in by the futures curve is premature.