26 July 2022
Broadly speaking, equities were buoyant last week, even amid the European Central Bank’s 0.5% interest rate rise – its first upwards move in over 11 years.
The base rate has been sub-zero since 2014, and now stands at 0.00%. It is expected that further increases will be made over the months to come, as the bank does its best to tackle soaring inflation.
Sky-high food and energy costs meant that consumer prices rose 8.6% in June, year on year – the highest figure recorded to date.
The announcement of interest rate hikes by central banks earlier this year saw a negative response from markets. However, last week, the MSCI Europe Ex. UK closed up 3%, with a similar story from the German DAX Performance and France CAC 40 indexes.
Azad Zangana, Senior European Economist and Strategist at Schroders, proposed that this market response could be because the changes were both expected and needed.
“The ECB should continue to raise interest rates at a steady and accelerated pace to reduce the risk inflation becoming entrenched. The Schroders forecast has the main refinancing interest rate reaching 1% by the end of this year, but it now appears that a target of 1.5% may be more appropriate.”
In the US, the S&P 500 went up by 2.6%, with the technology-heavy NASDAQ rounding off the week 3.3% higher.
Zahra Ward-Murphy, from Absolute Strategy Research Equities, suggested that equities might be bouncing as investors are, perhaps, more likely to believe that much of the negative news is already priced into the market, following a large correction over the course of H1 this year.
“Those taking this view were encouraged last week by a fund manager survey highlighting the significant extent to which investors had reduced risk and equity positions vs cash.”
Another potential driver behind this improved performance is that some are anticipating that central banks will have to reduce rate-rise plans as the economy slows.
This particular theory is set to be tested later this week, given that the US Federal Reserve is expected to increase its central interest rate by 0.75%, after US inflation reached 9.1%.
In the UK, meanwhile, as the combat for Boris Johnson’s successor played out – with Rishi Sunak and Liz Truss being the final two contenders – the FTSE 100 rose 1.6%. The two candidates have thus far been promoting two outlined conflicting fiscal policies, with Sunak declaring he would wait until inflation falls before cutting taxes, whereas Truss speaks of cutting taxes quickly.
Ruth Gregory, Senior UK Economist at Capital Economics, argues:
“What will really matter is the economic backdrop when the new PM walks into No. 10 Downing Street on 6th September (the winner of the poll of Conservative Party members will be declared on 5th September). We suspect that by the time the new PM takes office, the economy will be in a recession. That will make it very hard for even the more fiscally restrained Rishi Sunak to resist loosening fiscal policy.”
Central banks are trying to finely balance raising interest rates just enough to bring down inflation, but not so much as to trigger a recession. Yet with economic growth slowing in many markets, many believe some form of recession is likely this year.
Tom Beal, CIO of St. James’s Place, highlights that stock markets don’t always fall in recessions.
“A lot of that pain in markets is exhibited before you get into that recessionary period. So while it looks like we might be entering a recession from here, it doesn’t necessarily mean markets are going to fall.”
With one eye on the horizon, Kristina Hooper, Chief Global Market Strategist from Invesco, noted:
“Stocks have been beaten down. That doesn’t mean we won’t see more downside for some stock markets around the world, especially given that earnings expectations are likely to be adjusted downward. But I believe we are far closer to the bottom than the top — and meaningful positive catalysts could present themselves in coming months.”