Global markets remained under pressure in September, with the MSCI World Index (-4.2%) and MSCI Emerging Markets Index (-3.5%) falling deeper into the red as investors continued to assess the prospect of higher interest rates and a looming US government shutdown as divisions among US lawmakers have put the federal government at risk of a partial shutdown. US treasury yields edged higher as well, once again approaching 16-year highs and pushing the dollar to a 10-month high, amid speculation that the Federal Reserve will keep policy restrictive into next year, or longer. The ICE BofA MOVE Index, which tracks expected bond volatility, recently hit a monthly high.
US markets experienced a sizable sell-off towards the end of the month, with the S&P 500 trading down 4.5% at the time of writing. Investors continued to assess commentary from US Federal Reserve officials, with the repeatedly hawkish tone continuing to dampen sentiment despite the widely anticipated pause at the September meeting – the Fed kept the target range for the federal funds rate at a 22-year high of 5.25% to 5.5%, following a 25bps hike in July. The world’s largest central bank, however, signalled that there could be another hike on the cards this year. Projections released in the FOMC members’ interest-rate expectations dot-plot showed one more increase this year, followed by two cuts in 2024. Policymakers now see the fed funds rate at 5.6% this year, the same as in the June projection, while it is seen higher at 5.1% in 2024, compared to 4.6% seen in June. Twelve of the 19 Fed officials forecast another hike this year and there were fewer cuts forecast for next year. The market is now pricing in another hike this year – either in November or December, and the timing of the first cut has now been pushed to the third quarter of next year. The Fed lifted GDP growth forecasts as well and lowered unemployment projections – highlighting the bank’s expectations of a soft landing amid better-than-expected economic resilience, and in turn, upside risks to interest rates.
Moving over to the Asia Pacific region, the Chinese market (MSCI China Index: -4.9%) also remained in the red but saw some reprieve after a slew of economic data showed signs of a slight recovery in August – both industrial production (strongest pace of expansion in factory activity since February) and retail sales grew ahead of expectations, showing some resilience in the world’s second largest economy. This could be an indication that the country’s recent pro-growth policies are proving to be effective, with market participants now expecting to see a notable improvement in the Chinese economy towards the latter part of the year. However, concerns about China’s beleaguered property sector (which accounts for roughly a quarter of China’s economic growth) were exacerbated after trading in China Evergrande Group was suspended, again. This resulted in Chinese property developer stocks falling to levels last seen in 2011.
The JSE (All Share Index: -2.3%, -2.9% in USD terms) mimicked the downward trajectory seen among international peers as investors continued to monitor key global developments. In terms of local policy announcements, the South African Reserve Bank (SARB) kept its key repo rate steady at 8.25% during its September 2023 meeting, as anticipated, but emphasized that the fight against inflation was not yet over. Policymakers cited concerns about the continued depreciation of the rand and the ongoing pressures on inflation as the key drivers behind the decision – hence, a restrictive stance will be maintained until data affirms that price stability has been attained. Meanwhile, the SARB revised its inflation forecasts, with inflation for 2023 now projected to average 5.9% (prior: 6.0%). Simultaneously, policymakers raised growth forecasts slightly for this year to 0.7% (prior: 0.4%), in line with better-than-expected 2Q23 GDP data. This indicated the resilience of the productive side of the economy despite ongoing structural constraints, notwithstanding energy and logistical issues, which continue to threaten the economic outlook.
Economic Data Review
The US Federal Reserve paused, but maintained a hawkish rhetoric
Flash estimates showed that the S&P Global Composite PMI for the US decreased to 50.4 in August, in line with expectations. This marks the fourth consecutive month of declining PMI and signalled the weakest overall performance since February. Retail sales in August increased 2.5% y/y, compared to the 2.6% rise a month before - this was below expectations In July, the US trade deficit widened less than expected to $65 billion, as exports were up 1.6% and imports increased 1.7%. The unemployment rate in August rose to 3.8%, above market expectations. The annual inflation rate accelerated for a second straight month to 3.7% in August from 3.2% in July, above market forecasts of 3.6%. The Federal Reserve kept the target range for the federal funds rate at a 22-year high of 5.25% to 5.5% in its September 2023 meeting, following a 25bps hike in July, and in line with market expectations, but signalled there could be another hike this year. Projections released in the dot-plot showed the likelihood of one more increase this year, then two cuts in 2024.
The European Central Bank (ECB) hiked interest rates for the tenth consecutive time
On a preliminary basis, the HCOB Eurozone Composite PMI rose to 47.1 in September, compared to 46.7 a month before. This was above expectations of 46.5. However, the latest PMI reading still indicated a significant monthly decline in business activity at the end of the third quarter, primarily driven by a steep contraction in the manufacturing sector. Meanwhile, the rate of decline in services activity eased slightly. Retail sales in July were down 1% y/y, compared to expectations of a 1.2% decline. A trade surplus of €6.5 billion was recorded in July, compared to estimates for a €20 billion surplus, as imports tumbled 18.2% y/y and exports fell at a softer 2.7% y/y. The unemployment rate in July stood at 6.4%, matching consensus expectations. Consumer price inflation for August came in at 5.2%, slightly lower than expectations. The ECB hiked interest rates for the tenth consecutive time in September (compared to expectations for rates to remain unchanged) and signalled that it is likely done tightening policy as inflation has started to decline but is still expected to keep rates high for as long as needed.
The Bank of England (BoE) held rates steady, adopting a wait-and-see approach
Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 46.8 in September, missing market expectations of 48.7. Retail sales decreased 1.4% y/y in August, compared to forecasts of a 1.2% drop. In July, the trade deficit shrank to £3.45 billion from £4.79 billion in the previous month, as exports rose 1.8% y/y and imports dropped 0.2% y/y. In line with market expectations, the unemployment rate came in at 4.3%. Annual inflation in the UK dropped to 6.7% in August, below market expectations. The BoE held its policy interest rate steady at 5.25% in September, compared to expectations of a 25bps rate hike, keeping borrowing costs at their highest level since 2008, as policymakers opted for a wait-and-see approach following the latest inflation and labour data, which suggested that the accumulated impacts of previous policy tightening might be taking effect. It was the first pause in policy tightening in nearly two years, following the central bank's unprecedented 515bps hikes. Policymakers have reiterated their commitment to tightening policy further if deemed necessary.
Resilient data out of China sparks hope for an improvement in economic growth over the latter part of the year
China’s composite PMI slipped to 51.7 in August, from 51.9 a month before, in line with forecasts. This was the eighth straight month of growth in private sector activity but the softest pace since January, as a softer expansion in services activity was only partly offset by a renewed, albeit mild, increase in factory production. Retail sales increased 4.6% y/y in August, quickening from a 2.5% growth in the prior month and exceeding market estimates of 3%. Below market forecasts, the country’s trade surplus slumped to $68.36 billion in August compared to the previous month of $78.65, as exports dropped more than imports amid persistently weak demand from home and abroad. The surveyed urban unemployment inched down to 5.2% in August. China's consumer prices rose 0.1% compared with market forecasts of a 0.2% gain and after the first drop in over two years of 0.3% a month earlier. The People's Bank of China (PBoC) maintained lending rates at the September fixing, as policymakers assessed the impact of previous easing measures, including an interest rate cut in August and a recent reduction in the reserve requirement ratio for banks. China’s economy showed some signs of improvement in August, particularly in industrial production and retail sales. Inflationary conditions also improved after the country slipped into deflation earlier this year. However, the overall outlook for the economy remains uncertain, amid weak overseas demand and a property downturn.
The BoJ maintained an ultra-loose policy stance
Early estimates showed that the Jibun Bank Composite PMI reading in September fell to 51.8, from a final reading of 52.6 in the prior month, flash data showed. While pointing to the ninth straight month of expansion in private sector activity, the latest result marked the softest growth since February, highlighting the economy is struggling to maintain a strong recovery. Retail sales for July increased 6.8% y/y, exceeding market consensus for a 5.4% growth. Japan’s trade deficit decreased sharply to ¥930.5 billion in August, against market expectations of a shortfall of ¥659.1 billion. The unemployment rate unexpectedly increased to 2.7% in July. Annual inflation edged lower to 3.2% in August from 3.3% in the prior month, pointing to the lowest reading in three months. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations, and mentioned that it would patiently continue with monetary easing and respond to developments in economic activity. The committee reiterated it will take extra easing measures if needed, while being aware of rising inflation expectations.
Outlook
- 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.