By Jan Faure
Markets made further gains in November following better-than-expected US inflation data and as US Federal Reserve Chair Jerome Powell signalled a slowdown in the pace of interest-rate hikes. An easing in Covid restrictions and a real estate rescue plan helped Chinese and Hong Kong equity markets to rebound. In the US, the S&P 500 index gained 5.4% in November while the tech-heavy NASDAQ rose 4.4%. In Europe, the Euro Stoxx 50 index surged 9.6% while the UK’s FTSE 100 index added 6.7%. In Asia, Hong Kong’s Hang Seng index leapt 26.6% while Japan’s Nikkei gained 1.4%.
Weaker commodity prices, lower shipping rates and an easing in supply chain constraints are lowering input costs in the US. Headline inflation for October came in at 7.7% annualised, below expectation of 8.0%, and a significant decline from September’s reading of 8.2%. It was the lowest CPI print since January. Annualised core CPI, which excludes food and energy, was 6.3% (vs expectation of 6.5%). The data reinforced the view that inflation in the US has peaked.
The US dollar slumped against major currencies as investors adjusted to the prospect of less hawkish policy moves by the Fed. The British pound gained 5.3% against the dollar, while the euro and Japanese yen gained 5.5% and 7.6% respectively. At the same time US treasuries dropped, with the yield curve inverting even further. The US 10-year treasury bond has dropped 70 basis points from recent highs to around 3.50% currently.
Equities were buoyed late November following a speech by Jerome Powell on the outlook for the US economy. Powell said exactly what investors wanted to hear, saying “the time for moderating the pace of rate increases may come as soon as the December meeting.” Powell indicated that the Fed would balance tackling inflation with supporting the economy and affirmed market expectations that the Fed will raise interest rates by 50 basis points at its December FOMC meeting.
Powell acknowledged that the full effects of monetary tightening are yet to be felt. While he stressed that moderating the pace of rate hikes made sense, he said restoring price stability would require holding policy rates at a restrictive level for some time. Again, Powell emphasised that the Fed will “stay the course until the job is done”.
Across the Atlantic, things were less rosy as inflation continued to rise. UK inflation came in higher than expected at 11.1% year-on-year (vs expectation of 10.7%) with higher energy prices being the main driver. Headline inflation would have been 13.8% without the UK’s energy price cap. The Bank of England raised interest rates by 75 basis points to 3% and warned the UK is facing its longest recession since records began. In its outlook for the economy, the BOE said the UK would face a "very challenging" two-year slump while unemployment will nearly double.
Crude oil hit its lowest level since January as rising Covid-19 cases in China and protests against strict virus restrictions hurt commodity prices. China is the world’s largest importer of crude oil and many other commodities. With a low vaccination rate amongst the elderly, China’s primary approach to dealing with Covid-19 has been through mass testing and widespread lockdowns to suppress outbreaks. That approach has hampered energy demand and led to a build-up of resentment as other countries opened up.
Following Covid protests in Shanghai, Beijing and other major Chinese cities, the ruling party signalled an intention to make restrictions less disruptive and ease some controls. This lifted oil prices in the final days of November on expectation for a boost in fuel demand. Despite the late rally, brent crude ended November 9.9% lower at $85.43 a barrel (YTD -10.4%). If sustained, the decline in oil prices (from over $130 a barrel in March) will have deflationary effects early on in 2023.
With US midterm elections in the rear-view mirror, political risk has declined in the US. After recent dovish comments from Fed Chair Jerome Powell, investors will be hoping the 2-month rally in markets continues into December. The latest US indicators have shown the manufacturing and services sectors to be slowing, while employment and jobs data has been resilient. The labour market is a key determining factor behind the Fed’s future policy decisions. Should jobs market data deteriorate, the Fed could reduce rate hikes to 25bps or halt further rate hikes entirely early next year.
Despite recent optimism, many of the risks that plagued markets this year remain. The war in Europe continues unabated including the related European energy crisis, inflation in many parts of the world is at decade highs, China’s growth continues to stumble due to an inability to manage the Covid pandemic, and central banks have the difficult task of navigating their economies towards a soft landing (or trying to limit the extent of a recession). Meanwhile the outlook for company earnings has deteriorated as interest rate hikes take a toll on consumer spending.
As we enter the final month of the year, investors will keep a close watch on what the Federal Reserve has to say about inflation, interest rates and the economy. The final FOMC meeting for this year is mid-December and will likely determine whether a Christmas rally closes out a very challenging year. This year has been highly volatile but there have, as always, been opportunities available to investors.
We believe well diversified investors will see the light in 2023 after a tumultuous 2022. Looking into next year, there appear to be less event risks than what we experienced this year. Inflation is likely at or past its peak, while interest rate hikes should be far more measured as we approach the end of this rate hiking cycle.
China has been a major drag on global growth but there are promising signs that the two headline issues (Covid lockdowns and property market stresses) are being dealt with proactively. Finally, there will be hope for an end to a war that has had a devastating impact on many lives and livelihoods.
Table 1: Global Indicators – Local reporting currencies