Markets continue to look for signs of an interest rate pivot in the US
Bond yields, which move inversely to price, moved higher, as investors await the hotly anticipated speech from Jerome Powell, chair of the US Federal Reserve (Fed) on Friday, as interest rate policy continues to dominate markets. Expectations are high that without giving away any details on further rate rises, the Fed chair will be keen to burnish his credentials as being tough on inflation. With economic data beginning to point towards a slowdown, investors are looking for any sign of a pivot away from the current trajectory of rate increases, which has been running at an increase of 0.75% for the last two rate setting meetings. Currently markets are pricing in a peak in US rates of around 3.8% in March 2023, with peak rate expectations gradually increasing in recent weeks, with the peak priced in as low as 3.2% at the end of July.
As of 12pm on Friday, London time, US equities are down 0.7% over the week, whilst the US technology sector has fallen 0.5%. European stocks have lost 1.3%, and the UK market is down by a similar amount, having dropped 1.2%, not helped by the continued escalation in natural gas prices. The Japanese market is down 0.75%, whilst Australian equities fell 0.2%. Emerging markets bucked the trend, rising 0.2%, with Latin American stocks increasing by 3.1%, helped by the recovery in commodity prices in recent weeks.
Interest rate expectations gradually ratchet higher
Government bond yields rose, with shorter dated bonds rising the most. The yield on 2-year US Treasuries touched 3.40% mid-week, before settling back down at 3.37%. The 10-year Treasury is currently trading at a lower yield of 3.07%, meaning that the 2-year 10-year yield curve remains inverted, which many investors (but notably not the Fed) believe is a signal of an upcoming recession. The UK yield curve is also inverted, with 2-year gilts trading at a yield of 2.80% versus 2.61% for 10-year gilts. Whilst perhaps counter intuitively the German bund yield has yet to invert, with 10-year bunds trading at a yield of 1.35%. Futures markets are currently pricing UK rates rising to 2.8% by the November meeting, versus 1.75%, with rates rising to 4.0% by March. Whilst Eurozone rates are priced to rise from zero today, to 1.3% by December.
UK retail energy price cap rises by 80%, with further rises forecast
Gold fell 0.3% over the week, now priced at $1,758 an ounce, whilst industrial commodities continued their recent renaissance. Brent crude rose 4.4%, trading at $101 a barrel, copper was up 0.8%, at $8,167 a tonne, and European natural gas increased a whopping 28% over the week, priced at $318 a megawatt hour. On Friday the UK regulator increased the price cap on household gas and electricity bills from £1,971 a year to £3,549, an 80% increase. However, this is due to be reviewed again in January, with the latest industry forecasts suggesting the cap could rise to over £6,600 a year by the spring. If this comes to pass, this would be more than a fivefold increase on the price cap set in October 2021.
Bad news is good news as US economic data shows continued signs of softening
US home sales data softened further this week, as the annualised figure for July of newly built homes fell by 12.6%, versus forecasts of a 2.5% fall. Meanwhile the latest service sector purchasing managers’ index, which measures the business conditions service sector companies find themselves in, came in at a 27-month low of 44.1, with any reading below 50 representing contraction, also worse than forecasted. With a focus on interest rates, bad news is good news, as this drip, drip, drip of softening economic data may help the Fed to pivot on its rate hiking path. However, Neel Kashkari, president of the Minneapolis Fed, who has previously been perceived as more dovish on US central bank policy (less inclined to raise rates), was quoted this week saying that a combination of “maximum employment” and “very high inflation” makes the Fed’s approach “very clear, we need to tighten monetary policy to bring things into balance.”