October Market Update: The Turning Point?

What’s moving markets

There was no easing back into work after the summer hiatus. September offered plenty of economic news and central bank decisions for investment professionals to unpick and digest. We also saw indications that we might be reaching an inflection point in the ongoing interest rate hiking cycle from developed market central banks.

UK Consumer price index (CPI) inflation continued its decline (albeit marginally) in August, falling to 6.7% from the 6.8% recorded in July. This puts it at its lowest level since February 2022 with the biggest declines coming from falling food prices.

The core measure of inflation (which strips out volatile food and fuel prices) fell further to 6.2% from 6.9% in July and services inflation also eased to 6.8% (previously at 7.4%). This may have gone some way to relieve the Bank of England’s (BoE) concern that wage pressures were making price rises more persistent.

Given the continuing ‘good news’ on inflation, the BoE held interest rates at 5.25% in September, marking the end to a series of 14 consecutive rate hikes since December 2021 when interest rates were at a mere 0.1%. This wasn’t a unanimous decision though – the votes were 5/4 between holding and raising. Markets have generally now priced out any further interest rate rises from the BoE, however we expect rates will stay at their elevated levels until the second half of 2024.

The US saw inflation accelerate for the second straight month – a 0.6% rise from 3.2% in July up to 3.7% in August. This reflects higher energy prices, with the price of gasoline accounting for over half of the increase. Oil prices surged by nearly 30% in the quarter hitting almost $97 a barrel (Brent Crude), driven by cutbacks in supply from Saudi Arabia and Russia. There was some good news though. Core CPI fell to 4.3% in August from 4.7% in the prior month and its lowest level since September 2021.

In its September meeting, the Federal Open Market Committee (FOMC) kept its target range for the federal funds rate at 5.25%-5.5%, signalling that rates may stay higher for longer. And Jerome Powell again warned “we are prepared to raise rates further if appropriate and hold at a restrictive level until we’re confident inflation is moving sustainably toward our objective”, reiterating the Fed’s commitment to sustain a sufficiently tight policy to the bond markets. His comments, coupled with concerns around higher levels of issuance relating to larger future budget deficits, pushed yields on the US 10 year to 4.66%, the highest levels since 2007.

Despite the continuing relative strength in the US economy, this latest rise in borrowing costs will put further pressure on the soft-landing narrative we discussed in last month’s market commentary.

Unlike the Fed and the BoE, the European Central Bank (ECB) chose to raise interest rates for the 10th consecutive time in September, lifting the main deposit rate by 0.25% to 4%. This was despite earlier inflation data showing the headline Eurozone rate declining to 4.3% YOY in September from the 5.2% in August (an almost 2 year low) led by falling energy prices and services.

The outlook for China improved slightly over August with both retail sales and production growth reaccelerating and manufacturing activity also returning to expansionary territory. Naturally concerns over the Chinese real estate market continue to weigh on sentiment but the easing of reserve requirement ratios for Banks by policy makers can be seen as positive.

Asset class implications

Rising government bond yields injected a sense of reality into US markets throughout September leading to a broad-based fall in the FTSE USA index. The biggest detractions came from large growth stocks that have been dominating the US markets this year. The so called ‘Magnificent 7’ (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA & Tesla) have been driving almost all the gains in the S&P 500 in the first half of 2023.

The S&P 500 has delivered a return of 11.3% YTD but the index without those seven stocks has eked out just 0.2% - a remarkably dominant performance by such a small cohort.

Conversely, the FTSE All Share delivered a robust 1.82% return in September driven by large cap value stocks. These stocks which, much like the S&P 500 dominate the All-Share index, are mainly commodity orientated companies so have benefitted from rising commodity prices. Mid and small cap companies struggled during the month as the implication of higher for longer rates in the UK feeds through to negative sentiment and a realisation of the difficulties higher rates pose.

Bond markets delivered a tale of two halves in September. Government bond yields increased but their prices are declining following the higher for longer rhetoric and approach that now seems consensus by central banks. However, there’s been a tightening in credit spreads as corporates continue to show their strength, and therefore we’re seeing a broad-based rise in prices in both investment grade and high yield sectors.

Whether we’ve reached the inflection point of peak rates in developed markets or not, all asset classes will need to re-adjust to higher for longer interest rates. Some asset classes may have priced this in already, others, perhaps not, but as the old adage goes, the only free lunch in investing is diversification. We believe it's prudent for investors to follow this mantra into the last quarter of 2023 as it's unlikely to be quieter than those that have preceded it.

Disclaimer: This article is for general information purposes only and does not constitute investment advice. The commentary is intended to provide you with a general overview of the economic and investment landscape. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.