14th March 2023
Positive moves in the UK economy
It appears that the UK is starting to recover from the winter of economic discontent. Last Friday brought the news that the economy grew by 0.3% in January, following a decline of 0.5% in December 2022. This rebound was largely driven by the return of the Premier League after the break for the Qatar World Cup and an uptick in school attendance after the winter flu previously ran riot.
Although the news has kicked off sentiment that the recession headlines can be put on ice for a few months, it’s important to remember that the economy still has a lot of ground to recover. The same figures showed a fall in manufacturing and construction output.
Ruth Gregory of Capital Economics observed:
“Looking beneath the surface, the figures suggest the economy is on weaker ground than it appears. We doubt January’s strength will last and our hunch is that there will still be a recession.”
Azad Zangana of Schroders agrees that underlying challenges remain.
“Although we do not expect the Bank of England to raise rates any further, there is a delayed impact from rising rates. By the end of this year, many more households will have come off their fixed-rate mortgage deals and will face a sizable shock when they try to refinance.”
Interest rates drive market fluctuation
Globally, last week saw markets continue to fluctuate, as investors tried to get a handle on the higher-for-longer interest rate outlook.
The first major news of the week was the start of China’s annual National People’s Congress, with outgoing premier Li Keqiang announcing an economic expansion target of around 5% for 2023. Although this is the country’s lowest goal in three decades, it’s perhaps little surprise, given that the Chinese economy grew just 3% last year due to extended COVID-19 lockdowns.
Goldman Sachs said that achieving this modest target was “not challenging”. Indeed, China’s economic growth targets have been trending lower over the past decade as policymakers seek to control the country’s growing debt burden and boost domestic consumption.
Investors were encouraged that slowing growth in China was an anti-inflationary sign – hopes that were boosted by news of a drop in US factory orders. But the same couldn’t be said for European stocks – earlier gains were reversed on fears that the modest growth target suggested less demand for European goods.
Fighting the inflation “monster”
This was followed by Federal Reserve Chairman Jerome Powell giving his keenly awaited six-monthly testimony to the Senate Banking Committee midweek. He warned lawmakers that stronger-than-expected US economic data meant that the speed and size of interest rate hikes may also need to increase, and that “the ultimate level of interest rates is likely to be higher than previously anticipated”.
Markets are now pricing in a half-point increase at the Fed’s next meeting on 21st-22nd March – having been previously betting on a quarter-point rise. Powell’s hawkish tone was in tune with those of Christine Lagarde, president of the European Central Bank, who warned that further action was needed to tackle the inflation “monster”. Markets now expect European rates to rise from 2.5% to above 4%.
Unsurprisingly, stocks fell in response to Powell’s comments and the dollar hit multi-month highs, while US and German short-term bond yields broached their highest levels since at least 2008.
SVB shutdown causes ripple effect
So far so good in markets – but the relative calm was soon shattered on Thursday, in the wake of a dramatic sell-off in US banking stocks, which flowed into Europe and Asia on Friday.
This global rout in bank stocks was triggered by Silicon Valley Bank (SVB), a key lender to technology start-ups. The bank’s shares plummeted by more than 60% after it announced a $2.25 billion share sale to help shore up its finances. The action was prompted after SVB lost $1.8 billion when it offloaded a portfolio of assets, mainly US Treasuries. In the wider market, this led to worries about the value of bonds held by banks as rising interest rates made those bonds less valuable.
Late on Friday came news that US regulators had shut down SVB and taken control of customer deposits, signalling the largest failure of a US bank since 2008.
Gary Kirk of TwentyFour Asset Management believes SVB’s plight is an idiosyncratic regional event, and that the reported adverse effects on European lenders have been exaggerated. He highlights that European banks are less exposed to tech and crypto lending and tend to hold short-dated government bonds, reducing the risk of significant losses due to a forced sale. Additionally, European banks are typically better capitalised and better regulated than US counterparts. He commented:
“We expect this to be short-lived as investors begin to appreciate that with higher rates, the real benefit is stronger net interest margins actually strengthening the balance sheet. However, we would not be surprised to see more news stories like the SVB one coming from the US in the coming days.”
The slide underlined the edginess across markets ahead of the key US employment report on Friday. Prior to that came news on Thursday that US jobless claims had seen their largest increase in five months and that planned layoffs had jumped. Any signs of a weakening labour market are good news for the Federal Reserve as it seeks to quell inflation.
However, confirmation that the US economy added a further 311,000 jobs in February – surpassing expectations – suggested that January’s surge in hiring was not a one-time occurrence and solidified the view that the Federal Reserve will raise rates for longer.
The S&P 500 index slid 4.77% over the week but remains in marginal positive territory for the year to date.