Bond markets have continued the rally that set in after ten-year US Treasury yields reached 3.5% on 14th June, slipping a further 25bp over July to the current 2.75% level as the balance of probability appeared to shift quickly to recession. The US Federal Reserve announces its next move in a matter of hours, with widespread expectations of a further 75bp hike in the Fed Funds Rate to 2.5% - attention is now shifting to the September meeting and a further 50bp (?) rise then.

The US dollar has continued its relentless rise, 10% this year on the DXY trade-weighted index and 20% up from the lows of June last year. Jefferies points out that this 10% shift is ‘functionally equivalent’ to a 75bp rate increase. Add this to the Fed’s actual moves and that we have shifted from QE to QT and it is clear that a notable shift has taken place from monetary easing to monetary tightening. Markets are having to adjust to a period of monetary tightening into slower growth, here ends the ‘Fed Put’.

The UK Monetary Policy Committee meets next week, and we expect a further 50bp rise in the base rate to 1.75%. The UK Gilt market has mirrored the moves in America with ten-year yields falling further to 1.95% (having hit 2.65% in June). The two-year Gilt yield has slipped all the way back to 1.9%, clearly markets do not expect the current round of base rate increases to last for too long…

Credit spreads held their recent high levels for most of July but have shown some tentative signs of easing recently. We remain of the view that the yields on offer in UK investment grade corporate credit look attractive after this year’s shift in basis.

Meanwhile, the ECB has been attempting a volte-face with a ‘surprise’ jump in rates from nothing to 50bps. This did appear to pause the slide in the euro, which had fallen back to parity with the US dollar (the first time since 2002). But the ECB will struggle to get rates up by much (?1.25% by early next year) as the eurozone faces a number of problems from energy (Russian gas) to the demise of Mario Draghi in Italy and falling water levels on the Rhine.

Equity markets are putting in a cautious rally, notably in growth stocks, the US indices are now around 10% off their lows. With an economic slow-down, still high inflation and further monetary tightening in prospect, there must be pressure on earnings and this is unfolding in the current reporting season. On balance, we expect a continuation in the rally for ‘quality growth’ stocks but with macro instability in so many areas and that monetary squeeze building we could easily see a return of the volatile conditions of the first half.

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