August Market Update: Central banks take center stage

What's moving markets

After a few days of ‘will they, won’t they’, the US House of Representatives Speaker Nancy Pelosi became the highest-ranking American politician to visit Taiwan in 25 years when she travelled there with members of Congress in early August. The reason for her meeting with President Tsai Ing-wen is unknown but certainly raised tensions between the world’s two largest economies. The immediate response was an announcement of over water military exercises and some of the largest missile tests from China in decades.

The Bank of England raised interest rates for the 6th consecutive time by 50bps to 1.75%, the largest single rise since 1995. The Monetary Policy Committee voted 8-1 in favour of the increased hike with inflationary pressures the main reason.

Andrew Bailey presented a dire outlook for households, warning the UK is heading for more than a year in recession. Inflation is now predicted to rise to 13.3%, meaning families will be around 5% worse off by the end of next year. He was firm in his final comments: "to be clear, there are no ifs and buts in our commitment to the 2% inflation target. That's our job and that's what we will do."

This leaves the door wide open for more rate hikes in the coming months. Markets are pricing over 200bps of hikes by May 2023, taking the rate to 3.75% in pretty short order.

UK inflation (CPI) hit its highest in 40 years, reaching double figures and beating economist expectations at 10.1% compared to the expected 9.8%. The main driver was food and fuel. Despite the price at the pumps coming down in recent weeks, the annual increase stood at nearly 44% over the year to July. This adds greater expectation of further UK rate hikes.

Consumer confidence, indicating the state of the UK economy was also disappointing, hitting the lowest numbers since comparable records began nearly 50 years ago. This survey is taken in the first 12 days of each month so Andrew Bailey’s recession headlines and news of the deepening cost of living crisis would be fresh in everyone’s minds.

Inflation in China also hit a 2 year high in July, albeit significantly lower than other major economies at 2.7%, lower than the expected 2.9%. The major contributor was surging pork costs, but weak consumer demand generally kept a lid on inflation. In stark contrast to most central banks, China trimmed its key lending rates and added stimulus in August - an attempt to revive an economy hurt by lockdowns and property issues. Generally, the consensus has been underwhelming and economic growth forecasts for 2022 have been cut to 3.5%.

The headline act was still to come. Fed Chairman Jerome Powell took to the stage at the annual Jackson Hole economic symposium in hawkish style, reiterating their focus on the 2% target and vowing to “keep at it until the job is done.”

Asset class implications

The significant shift in UK rates, followed by hawkish rhetoric from the Bank of England, led to a sharp rise in gilt yields and a subsequent fall in price. The 2 Year Gilt yield is more sensitive to interest rate changes and rose over 120bps from 1.75% at the beginning of August to over 3% at the end of the month, while the 10 Year Gilt Yield moved from 1.86% to over 2.80%. As the quant data shows, this led to another significant shift down in pricing after some relief from the selloff through 2022 in July.

Despite the bombardment of negative headlines throughout August, equity market returns (GBP) were fairly flat or in some cases positive. The trend was similar across all regions with equity prices rising in the first part of the month then tailing off and giving up most of the mid-month gains by close. The US was up nearly 6% mid-month before Jerome Powell put the brakes on risk appetite.

Emerging Markets were the standout performer through August, bringing the asset class to the top of the pile, though still providing a negative return of -0.74% since the end of December.

The cost-of-living crisis is showing no signs of abating. In the US the National Energy Assistance Directors Association quoted 1 in 6 American homes have fallen behind on utility bills. This is the worst crisis the group has ever documented. The issues are the same if not worse in Europe and the UK with energy prices soaring and cost of borrowing rising.

One potentially positive signal is that the price of key raw materials like oil, copper and wheat have cooled. This is leading to the possibility that global inflation will peak soon. However, a surprising jump in US job openings and persistently strong consumer confidence in the US is making the Feds job of tempering inflation while not sparking a recession incredibly difficult.

These conflicting forces are a perfect recipe for heightened volatility across all asset classes. Diversification is paramount in maintaining investment discipline through these periods and that is one of our key principles in PIM.

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.