Stocks pull back on Central bank tightening concerns

Global equity benchmarks pulled back last week, paring some of the gains from the recent impressive rally as the MSCI All Country World Index ended down by 1.6%. Bond yields jumped on the re-emergence of concerns surrounding hawkish central banks, weighing on market sentiment.

The move in the fixed interest space was keenly felt in the UK as 10-year gilt yields rose by 30 basis points, driven by a new cycle high for inflation and stated policy plans of Liz Truss, the strong favourite to be announced as next prime minister in the coming weeks. The UK’s headline inflation rate hit 10.1% in July, the highest level in over 40 years. A sharp rise in food costs played a central role in pushing the measure into double digits but there was also a higher than expected core reading, which strips out food and energy prices, that rose to 6.2%.

Whereas hopes are rising that US inflation has topped out, things are expected to get worse before they get better for the UK and Citigroup forecast inflation could reach as high as 18% in early 2023. One key driver of this will be the new price cap from energy regulator Ofgem, which is scheduled to be announced this week for the three-month period beginning in October. Another important aspect of price pressures will be the new government and any policies taken to help consumers with energy bills, although at present Liz Truss has given little indication that she would support strong measures on this front.

UK large-cap equities bucked the trend last week by ending higher, with benchmarks showing gains of around 0.9%. The increase was driven by a currency depreciation with sterling sliding to 1.18 US dollars per pound and providing a de facto boost to many of the benchmark’s multinational companies that generate revenues overseas.

The UK labour market remains strong, although there was a small 0.1% uptick in the unemployment rate to 3.8%. 1.27m job vacancies in the three months to July marked a small drop from record levels but is also suggestive of a tight jobs market. Wage growth (excluding bonuses) increased to an annual rate of 4.7% in the second quarter, but with inflation running significantly higher this meant a real wage decline of 3.0% – the largest fall in more than 20 years.

Resilient US data

Economic releases from the US showed activity in the world’s largest economy continues to hold up well, although the strength of the data is seen by some as fuelling fears of further interest rate increases. Industrial production for June and the latest weekly jobless claims figures were better than expected. There remains something of a paradox around US consumers, with core retail sales figures for July exhibiting further strength while consumer sentiment readings continue to reside close to their lowest levels in years.

The release of the minutes from the Federal Reserve’s last policy meeting contained little by the way of surprises but speeches from voting members since then have been on the hawkish side. Later this week, Fed chair Powell will speak at the annual Jackson Hole Symposium and investors will be listening carefully for any hints of a deviation from the current hiking path in the coming months. US large-cap benchmarks fell by around 1.2% last week in fairly subdued trading conditions that are typical of the summer months. The US 10-year Treasury yield ended the week at 2.98%, up 15 basis points.

Core eurozone government bond yields also moved higher, supported by hawkish comments from ECB officials. Isabel Schnabel stated that the eurozone’s inflation outlook had not improved since the central bank hiked by 50 basis points in July, in comments that were taken to suggest support another sizable increase in September. Economists now see a eurozone recession as more likely than not, according to a recent poll by Bloomberg. The German 10-year bund yield increased 25 basis points to end the week at 1.24%. European equity markets broadly tracked their US counterparts, with pan-European indices falling by around 1.2%.

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