September has seen a further deterioration in markets, culminating in a disorderly end to the period with steep falls for equity and bond markets, and, for a change, the makings of a currency crisis.
The US Federal Reserve raised the Fed Funds Rate by 75bp (now up to 3.25%), the European Central Bank (ECB) also raised by 75bp, the Bank of England limited itself to 50bp (in a split decision), though, to be fair to the Bank, it was the day before the new UK Chancellor’s fiscal package (not to call it a mini budget). With the accompanying tough talking from the central bankers, bond prices slumped, and yields rose along the curve. The major central banks are continuing to signal that more tightening will be needed to bring inflation back to target while admitting that an economic contraction is a means to this end.
The US yield curve has fully inverted now, the two-year yield rising to 4.3%, ten-year to 3.8% and thirty-year to 3.7%. A mild recession in the US looks likely now. The ECB’s hawkish tones confront a European economy already in recession. The UK Chancellor’s package delivered even more tax cuts than had been trailed, the lack of an accompanying budget or plan to pay for all these cuts quickly led to a focus on the potential inflationary effects, higher yields and weaker sterling.
Gilts have taken a hammering in recent days with the two-year yield jumping to 4.4% and the ten-year to 4.25%. The effect of duration on longer dated issues has been dramatic: the thirty-year Gilt has fallen a further 30% in value over this past five weeks, taking it to a fall of 56% over the year. This is what ‘normalisation’ looks like when played out at pace, we are now back into the yield range that persisted for the ten years from 1998 to 2008.
Equity markets have followed suit with falls of around 12% for the S&P 500, taking it back, almost exactly, to the end-June low points. All the major world markets fell, the only gainer was volatility. Interestingly, though possibly not a surprise, the price of oil has also fallen back along with metals prices.
It is still all about inflation. In the short-term, consumers and businesses are to be shielded from the prospect of massive jumps in fuel prices (though these are abating somewhat), which will provide significant relief. We expect inflation to begin to abate over the next six months but, remember that it is a lagging indicator and what matters to the markets is the time when they can see that the Federal Reserve really means what it says.
Europe was in the eye of the storm of gas prices and the ghastly Putin, now the storm has crossed the channel to the UK. Falls in sterling are inflationary (though much of this has been US dollar strength), a tax-cutting budget can be inflationary (unless the cuts can really be covered), both increase the odds of a tougher response from the Bank of England.
The better side of the coin is that, for the first time in years, one can see decent returns on offer in the Gilt market and even better returns on offer in credit markets. My suspicion is that markets (fixed interest and equity) have priced-in a lot of bad news and that fortune will favour the disciplined buyer of quality companies now. But… in the short-term, it feels like it could go anywhere…
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Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.