2 August 2022
Interest rates on the up
US equities had a strong bounce last week, in spite of the Federal Reserve’s move to raise interest rates and GDP data revealing that the US economy shrank in the second quarter – emphasising precisely what a challenge it can be to forecast market movements.
This is the second consecutive interest rate hike, and this was fully expected, with the Fed saying it anticipates further increases to lower inflation.
US economic prognosis
In other news, economic data indicated that the US economy dwindled in Q2, leading many economists to announce that the US is in a recession – in other words, suffering two quarters of GDP falls.
On the other hand, some have claimed the situation goes deeper than this. Following the rate rise, Fed Chair Jerome Powell commented:
“I do not think the US is currently in a recession. And the reason is there are just too many areas of the economy that are performing too well. And of course, I would point to the labour market in particular. It is true that growth is slowing, and for reasons that we understand really, that growth was extraordinarily high last year – 5 and a half percent – we would have expected growth to slow.”
Even though the economy is struggling, US unemployment remains at a 50-year low of 3.6%, and wages continue to increase (despite being below inflation).
It may have come as a surprise to witness markets perform so positively last week, given that the US continues to raise interest rates and is potentially in a recession.
The language Powell used when talking about the future was one reason for this. The next rate rise won’t be for several weeks, and while Powell said that a further sizeable increase could be fitting, this would all depend on new data released by then.
“It likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.”
Markets responded positively to this apparent more moderate stance, with the S&P 500 closing the week up 4.3%.
This rounded off a somewhat strong two weeks for equities.
Even against the gloomy economic backdrop, David Bowers – Global Strategist at Absolute Strategy Research – mentions that since 16 June, the MSCI World, S&P 500 and NASDAQ have jumped 8%, 11% and 14% respectively.
He did, however, give a clear warning:
“Our instinct is to see this as a bear-market rally. Remember, this rebound in equities comes after a brutal sell-off in the first half of 2022. Let’s not forget that between 30 December 2021 and 16 June, the S&P lost 23% and NASDAQ fell 32%.”
A mixed Euro-bag
In Europe, headline Eurozone economic growth of 0.7% surpassed market expectations, helping to boost markets. The MSCI Europe Ex. UK concluded the week up 2.4%.
Looking to the future, European markets don’t have quite so rosy an outlook. Most of the GDP growth was driven by Spain, Italy and France, whereas Germany – Europe’s largest economy – was flat.
Europe finds itself in the face of multiple headwinds. For example, Russia has reduced its shipping of gas to Europe, and it would appear that Putin plans to continue weaponising energy. What’s more, the resignation of Italian Prime Minister Mario Draghi means the country will soon enter an election where populist leaders might gain more central influence.
Azad Zangana, Senior European Economist and Strategist at Schroders, noted:
“We continue to expect reasonable growth for southern member states, which have not enjoyed a full tourism season since 2019. However, it’s clear from Germany’s performance that global capital investment has slowed in response to rising interest rates and concerns over growth. China’s draconian lockdowns have not helped matters either. With the heavy reliance on Russian gas to consider as well, it appears that the northern member states are particularly vulnerable going into the next two to three quarters.”
UK growth backdrop
In the UK, meanwhile, a set of strong corporate earnings meant the FTSE 100 finished up 2.0%. This week will probably see another forecasted 0.25% interest rate hike in the UK, when the Bank of England meets.
In the political sphere, Rishi Sunak and Liz Truss continue to promote their vision of the future of the Conservative Party. According to Mark Dowding, Chief Investment Officer at BlueBay:
“It seems increasingly likely that Liz Truss will be chosen as the next UK Prime Minister by Tory Party members. This may mean more tax cuts (plus a desire to influence the Bank of England not to hike rates too much) in order to improve the growth backdrop. However, we see a real risk that this will end up perpetuating the inflation overshoot in the UK in 2023.”