Global markets swung into the red in August with the MSCI World Index and MSCI Emerging Markets Index trading down around 2.2% and 5.4% respectively towards the end of the month. Sentiment was mainly dominated by two key themes, namely the rate hike path in the US and weaker-than-expected growth in China. While market participants are of the view that recent stimulus measures introduced by the People’s Bank of China (PBoC) are relatively conservative, Chinese authorities have promised to step up policy support and accelerate government spending as the post-Covid-19 economic growth trajectory has continued to disappoint the market.
US markets were under pressure for most of August but saw some reprieve towards the end of the month, with the S&P 500 trading down 1.5% at the time of writing. Policy speculation remained at the forefront, with US Federal Reserve Chair Jerome Powell's speech at the Jackson Hole Symposium reaffirming that the Fed remains hawkish. While any further action will be data dependent, Powell was clear that the Federal Open Market Committee (FOMC) is “prepared to raise rates further if appropriate” and intends “to hold policy at a restrictive level” until the inflation outlook is sustained at around the 2% level. The US economy remains resilient and hence policy rates are expected to remain elevated for the remainder of 2023 and into the first quarter of 2024. However, recent labour data showed a decline in US job openings, which could be a sign that the jobs market is softening after remaining incredibly resilient despite slowing economic growth and restrictive monetary policy. The market is currently pricing in a 11.8% probability of a hike in September, a 39.1% chance of a hike in November, and a much higher likelihood that cuts could start as early as March next year.
Moving over to the Asia Pacific region, the Chinese market (MSCI China Index: -8%) remained under strain and was one of the worst performing within the emerging market basket. Economic data releases from the world’s second largest economy have generally been softer than expected, confirming that additional intervention is required not only on the monetary front, but in the form of extra fiscal thrust as well. Monetary authorities have already beefed-up support through a range of measures including the reduction of short- and medium-term lending rates, injecting liquidity into the economy, and support for the local currency. Analysts are now expecting a cut in reserve requirements in the fourth quarter and a possible (long-term) interest rate cut this year. Recent pledges made by the finance minister and the chairman of the National Development and Reform Commission sparked notions that Chinese authorities may be becoming more proactive in fiscal intervention in the economy. The health of the Chinese economy is of vital importance to the global growth outlook and demand for commodities.
The JSE (All Share Index: -4.4%, -8.6% in USD terms) tracked global peers lower as investors remained focused on the key issues dominating global markets. The rand experienced large swings against the greenback (a function of US dollar strength and general weakness among commodity producer currencies, amplified by general risk-off sentiment), breaching the R19 to the dollar mark earlier in the month, but has since strengthened to around R18.68/dollar. In terms of local economic data, CPI was lower than expected at 4.7% in July from 5.4% in June. The slowing in inflation closer to the 4.5% target, should support gradually lower inflation (and interest rate) expectations over time but monetary policy in the US, adverse risk sentiment should China’s prospects not improve, and SA’s fiscal outlook worsening, may suggests that local rates will remain restrictive going into 2024, when potential easing comes into the narrative.
Economic Data Review
The US Federal Reserve will maintain a restrictive stance until inflation reaches the target range
Flash estimates showed that the S&P Global Composite PMI for the US decreased to 50.4 in August, below expectations. The latest reading indicated the softest pace of expansion in private sector activity since February, with a contraction in the manufacturing sector accompanied by lower service sector output. Although annual inflation picked up to 3.2%, this was still lower than the forecasted figure of 3.3%. Retail sales in July increased 3.2% y/y, compared to the 1.6% rise a month before. This was well ahead of expectations. Back in June, the US trade deficit improved to $65.5 billion (consensus: deficit of $65 billion), as imports edged 1% lower y/y, while exports dipped marginally by 0.1% y/y. The unemployment rate in July decreased to 3.5%, slightly better than expectations. At the recent Jackson Hole Economic Symposium, Fed chair, Jerome Powell, suggested that further rate hikes are still necessary to manage sticky inflation, and that while the central bank would continue to evaluate all available signs before making a certain decision, it seems likely that rates will be held steady at the next meeting in September. The central bank remains committed to achieving its inflation target of 2%.
The European Central Bank’s (ECB) rate hike pushed interest rates to its highest level since 2008
On a preliminary basis, the HCOB Eurozone Composite PMI decreased to 47 in August, compared to 48.6 a month before. This was below expectations of 48.5. This reading is indicative of the sharpest contraction in private sector activity since November 2020. Services output fell for the first time since December 2020, while manufacturing output contracted at the second-strongest pace over the past eleven years. Retail sales in June were down 1.4% y/y, compared to expectations of a 1.7% decline. A trade surplus of €23 billion was recorded in June, compared to consensus estimates of a $18.3 billion surplus, as imports tumbled 17.7% y/y and exports inched 0.3% higher. The unemployment rate in June stood at 6.4%, below market estimates of 6.5%. Consumer price inflation for July came in at 5.3%, in line with consensus expectations. The ECB raised its key interest rates by 25bps to 4.25%, the highest since 2008, as expected. Speaking at the Jackson Hole Economic Policy Symposium, ECB President, Christine Lagarde, said that interest rates in the Euro Area will remain high as long as necessary to slow the still-high inflation.
The Bank of England (BoE) will ensure that bank rates remain sufficiently restrictive as core inflation remains sticky
Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 47.9 in August, missing market expectations of 50.3. Retail sales decreased 3.2% y/y in July, compared to forecasts of a 0.5% drop. In June, the trade deficit shrank to £4.8 billion from an upwardly revised £7.7 billion in May, as exports remained flat m/m and imports fell 3.9%. The unemployment rate came in at 4.2%, above market expectations. Annual inflation in the UK dropped to 6.8% in July, in line with market expectations. The BoE raised the policy rate by 25bps, marking the fourteenth consecutive rate increase, also in line with market expectations. The decision was spit 6-3 in favour of the 25bps hike, with two members voting for a 50bps hike, and one preferring a pause. The BoE noted that rates are now in restrictive territory, and that it intends to make sure that the bank rate is sufficiently restrictive for as long as is needed for inflation to return to the 2% target. The central bank now expects inflation to fall to around 5% by year end.
Chinese authorities are expected to be more proactive in terms of fiscal intervention
China’s composite PMI slipped to 51.1 in July, from 52.3 a month before, and below forecasts of 52. This was the lowest reading since December 2022. The outcome was underpinned by a contraction in factory activity for the fourth straight month, and the lowest expansion in the service sector in seven months. Retail sales increased 2.5% y/y in July (+3.1% y/y in June), far below market consensus of 4.5% growth. Ahead of market forecasts, the country’s trade surplus increased to $80.62 billion in July as exports fell more than imports amid persistently weak demand from home and abroad. The surveyed urban unemployment inched higher to 5.3% in July. China's consumer prices fell 0.3% y/y into deflationary territory, coming in below market expectations and June's figure of 0%. The PBoC cut its one-year loan prime rate (LPR) by 10bps to 3.45%, a record low, while the one-year medium-term lending facility rate was slashed by 15bps. However, the five-year rate was maintained at 4.2%. The PBoC has promised measures to release more liquidity for the economy, as it seeks to strike a balance between stimulating the ailing economy and stemming further weakness in the yuan.
Japan has a positive economic outlook, with the moderate recovery being supported by pent-up demand
Early estimates showed that the Jibun Bank Composite PMI reading in August was 52.6, up from a final reading of 52.2 in July, flash data showed. This was the eighth straight month of growth in private sector activity, and the sharpest increase in three months, with the services sector driving growth for the third straight month in a row, while manufacturing activity contracted for the third month running. Retail sales for June increased 5.9% y/y, in line with market consensus. Japan also unexpectedly recorded a trade deficit of ¥78.73 billion in July, against market expectations of a ¥24.6 billion surplus. The unemployment rate fell to 2.5%, in line with consensus expectations. Annual inflation stood at 3.3% in July, missing market forecasts of 3.1%. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations. The BoJ decided to make its yield curve control policy more flexible amid efforts to improve the sustainability of stimulus policy. The bank’s outlook on the economy is positive, with a moderate recovery expected amid pent-up demand. The board has reiterated its goal of expanding its monetary base until inflation exceeds the 2% target.
- 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.
- 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. Moreover, the reactivation of over $1.6 trillion of student debt in October may well present a headwind to future earnings prospects.
- Nevertheless, if liquidity remains plentiful, the emergence of price discovery in the short-term could be prevented. It is worth noting that the Fed has articulated the need to tighten financial conditions, but the opposite has occurred. We believe that the loosening of financial conditions in recent months could embolden the Fed to remain restrictive for longer to bring core inflation levels down to more sustainable levels.
- We expect growth to slow in other developed markets, particularly in the Eurozone and the UK. Monetary policy will likely remain restrictive as inflation levels remain well above central bank targets. As a result, consumers and businesses will face higher borrowing costs in the near-term.
- In emerging markets, it is certainly encouraging to see the PBoC ease monetary policy conditions further by slashing several different interest rates. However, continuing weakness in coincident to lagging economic data, particularly sluggish consumption expenditure amid pre-payment of mortgages by locals, highlights a potential confidence issue in the broader economy. With low levels of inflation and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities.
- Once peak hawkishness of the Fed has been sufficiently priced in by market participants, labour market weakness emerges and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. For now, T-bills remain more attractive with a higher yield compared to longer duration bonds.