By Jan Faure
Economic data released in July provided further evidence of a slowing global economy, while inflation continued to rise to new highs and flash PMIs indicated that activity was losing momentum. US equity markets staged a strong July rally as negative economic data boosted the view that the US Federal Reserve will ease the pace of monetary tightening in the months to come.
Global growth stocks benefitted most, delivering 11.5% total return in July, which helped recover some of the heavy losses year-to-date. Declining sovereign yields and tighter credit spreads drove high yielding fixed income. In the US the S&P 500 index gained 9.1% for the month. European equities were firmer while equity markets in China and Hong Kong declined sharply on growth and regulatory concerns.
The US inflation rate accelerated to 9.1% in June (from 8.6% in May), the highest level since November 1981. Again, the main culprit was high energy prices with gasoline prices increasing by 60% y-o-y. At the Federal Reserve’s policy meeting following the inflation data, the committee raised interest rates by a further 75 basis points. July’s move brings the cumulative total to 2.25% in rate hikes since March this year.
Fed chairman Jerome Powell acknowledged that parts of the US economy is slowing, but said the bank was likely to keep raising interest rates in the months ahead despite the risks. Powell did mention that a more moderate rate rise in September is possible but will be dependent on data showing clear price stabilisation and an overall softening of the labour market. Markets rallied off the back of this, hoping that the worst was behind for the US economy.
The labour market has been resilient so far this year and supports the view that a US recession in the near-term seems unlikely. Payrolls data for June was better than expected and the unemployment rate remained at a low 3.6%. The resilient US labour market has allowed the Fed to focus its efforts on the bringing inflation under control because it hasn’t had to worry about preserving jobs – the Fed has a dual mandate of price stability and maximum sustainable employment.
Second quarter US GDP declined by -0.9% (QoQ annualised) led by a drop in home building and commercial property investment. US consumption spending, the backbone of the US economy, slowed as inflation and interest rate hikes began to bite. A second successive contraction in quarterly GDP is considered a technical recession, although it is not officially considered so until recognised as such by the National Bureau of Economic Research. US employment, household finances and consumer spending are all still robust.
The negative GDP news encouraged the market bulls, with US indices rallying on hopes that the Fed will slow the pace of future interest rate hikes. In a further sign that investors expect an easing of the Fed’s aggressive policy stance, US Treasuries yields declined. The 10-year yield fell to 2.67% at month-end, well down from June's peak of 3.48%, suggesting expectations for future rate hikes are easing.
The European Central Bank raised interest rates by 50 basis points (double expectations) for the first time this year, bringing to an end eight years of negative interest rates. The increase takes the ECB’s deposit rate to 0%.
A widening of the interest-rate differential between Europe and the US, as well as greater recession risk, saw the Euro currency reach parity with the US dollar in mid-July. Europe faces the real possibility that Russia may cut off gas supply to Europe which would almost certainly plunge the region into recession. The ECB is far more dependent on Russian oil and gas than the rest of the world. Taming decade-high inflation with war and an energy crisis on their doorstep is an incredibly difficult challenge. The ECB has the additional challenge in setting monetary policy that applies to a group of different countries.
Notwithstanding the Russia-Ukraine conflict, China has remained the problem child to the post-Covid global recovery. Renewed surges of Covid cases in China, including the mega cities of Shanghai and Beijing, have caused Chinese economic growth to falter this year. The Chinese government seems resolute in maintaining a zero-Covid policy while attempting to correct slowing growth with a series of stimulus plans.
Second quarter company earnings season is well underway in the US. At end-July, just over 56% of S&P 500 companies had reported earnings with 73% having beaten analyst earnings estimates. Some of the big-name companies to report better than expected results included Amazon, Apple and Microsoft, boosting technology stocks overall. So far it has been more a sigh of relief than excitement over stellar financial results. Analysts were particularly concerned around advertising revenues and e-commerce spending in the face of high inflation and weaker consumer sentiment. Another key theme has been the impact of the surging US dollar on foreign revenues.
July saw the global economy beginning to feel the impact of high inflation and attempts by central banks to curb inflation. Overall, recession risks have risen. Potential earnings downgrades are a risk to equity markets despite market declines year-to-date driving a de-rating in valuations. Volatility was elevated in the first half of the year, pointing to uncertain times. There are however promising opportunities for patient investors.
Table 1: Global Indicators – Local reporting currencies