Weekly Comment: Equities pullback as Powell sidesteps chance to pivot

Global stock markets came under pressure at the back end of last week after Jerome Powell, chair of the Federal Reserve (Fed), reiterated the central bank’s determination to continue raising rates to tame high inflation. The MSCI All Country World Index fell by 2.9% on the week, with the bulk of the declines occurring on Friday. The reaction in fixed interest markets was more muted, although also reflective of a hawkish message, with bond yields moving back higher.

There was not much new in Powell’s short speech at the annual Jackson Hole symposium. Rather, it was what he did not say that triggered the market reaction, with the absence of any reference to a forthcoming shift in Fed policy causing selling in equity markets. The overall tone was in keeping with several comments from other Fed officials, with Powell effectively pushing back on any suggestion of a big pivot in early 2023.

Shortly before the address, there was more good news on the inflation front, as the latest core personal core expenditure price index rose less than expected in July, increasing month-on-month by 0.1% versus and consensus forecast of 0.2%. The previous month’s reading was 0.6%. This supports the most recent US consumer price index reading and suggests that inflationary pressure in the US may have peaked.

That said, these gauges remain at elevated levels and even if they do return back to the Fed’s 2% target, the journey lower is expected to be protracted. Powell stated that rates will need to remain in restrictive territory for some time and that this will bring some pain for businesses and households. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” he said.

Domestic markets dropped more than global peers following the speech, with large-cap US benchmarks ending the week down by around 4%. High-growth and technology stocks fared worst, with tech indices falling to their lowest level in a month. Following a strong rally off the year-to-date lows, US benchmarks handed back around a third of the gains made since the June bottom.

The US 10-year treasury yield rose by nine basis points last week, moving back above the 3% level to end at 3.07%. Derivatives markets are now largely pricing in a 75 basis point increase from the Fed at its September meeting and discounting one rate cut in 2023.

ECB to raise again

Before the Fed’s next monetary policy meeting the European Central Bank will convene for its next interest rate decision, where it is expected to announce another increase. The latest rhetoric from Governing Council members has been hawkish and there is little to suggest they won’t follow up July’s 0.5% hike – the first increase in the base rate in more than a decade – with another rate rise.

The European Union is preparing emergency measures to curb the price of electricity in a bid to ease the energy crisis in the bloc. No concrete measures have been announced yet, but an emergency meeting in the coming weeks is expected to deliver further details ahead of the winter.

Much of the region’s electricity relies on gas for its generation and the price of gas has soared since Russia’s invasion of Ukraine. Last week natural gas prices jumped to record levels after Gazprom, Russia’s state-owned natural gas producer, announced plans for additional closures of the Nord Stream 1 pipeline to Europe for maintenance.

European equity benchmarks fell by around 3.4% last week, taking the year-to-date losses to approximately 13.7%. Core eurozone government bond yields gained on the expectation of more sharp interest rate increases and concerns of an economic slowdown. The German 10-year bund yield rose by 11 basis points last week, ending at 1.34%.

Liz Truss, favourite to be announced next week as the UK’s next prime minister, reportedly plans to ease the energy crisis with a large VAT cut. The suggested move drew criticism and was branded “regressive” for its failure to target the support measure at those most in need. It is also seen as adding to inflationary pressures.

As has been the case for much of 2022, UK stock benchmarks held up better than their peers in a falling global market, sliding around 1.5% last week and remaining in positive territory for the year. The pound remains near its lows against the US dollar at US$1.18. The 10-year gilt rose strongly on the week, increasing to 2.60% from 2.41%.

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