Uncertain Certainties
Short-term interest rates are rising further but by how much?
After the rally in financial markets in July, almost all financial markets fell sharply in the final week of August. The sell-off was largely a consequence of US Federal Reserve Chair Jerome Powell’s speech at the annual Jackson Hole symposium in Wyoming. The much-awaited speech underlined the US central bank’s determination to control rising inflation.
Having bounced from oversold levels in June/July central bank hawkishness, led by the US Federal Reserve, left investors in no doubt that monetary policy setters will take risks with recession in the fight to tame inflation. Higher food and energy prices are a tax on consumers’ disposable spending so economic activity will ebb as a consequence. The problem for central bank policy makers is tight labour markets, wage pressures and strike actions on the rise, increasing the chances of a wage/price spiral. However, the extent of the negative reaction to Powell’s Jackson Hole delivery was something of a surprise given various Fed governors and Powell himself had already alluded to a more aggressive stance on monetary policy.
The only real hiding place from negative market forces at the end of August was US dollar cash. Rising short term interest rates, relatively higher than other countries and projected to remain so with a more resilient economy, have propelled the US currency to new levels. The US currency is now historically expensive on a trade-weighted basis but history reminds investors that it can take some time for that to change. Below is the chart of the US trade-weighted index (DXY) year-to-date:
Source: Tradingview.com
Economic data has pointed to a conflicting view of the US economy.
The CEO Survey points to a recession:
Source: Charles Schwab
The Job Openings data pointed to the employment market remaining tight as openings rose in the latest data release for July:
Government bonds, supposedly safe-havens in times of stress, suffered in August and like other markets, especially after Jackson Hole. UK Gilts in particular, faced with political uncertainty/vacuum and increased supply alongside a deteriorating inflation picture, took it on the chin with yields rising (prices falling) precipitously for ten year maturities as the following graph illustrates. Government bonds are an asset class that do not feature in the T. Bailey multi-asset funds. Both the FT UK Gilt and Index-Linked Indices fell by over 7% in August.
Source: Trading Economics
For those who sought the benefit of higher yields from investment grade and below investment grade (high yield) debt, there proved to be no benefit as spreads to government bonds widened. These forms of debt are also absent from the T. Bailey multi-asset funds.
The prospect of weaker economic growth across developed and developing economies was not a positive backdrop for commodities but supply concerns helped most post a positive return for August despite the final week sell-off. Agricultural commodities led the commodity pack with a strong outcome for August of plus 7% in aggregate. Oil oscillated during the month on demand/supply considerations but posted a negative return overall.
While global equities suffered in the final days of August, most achieved positive returns over the month. Like other asset classes, any US dollar translation into sterling was a positive influence for UK investors. The regional laggards posting negative monthly returns were Europe and the UK due to political and inflationary concerns. Asian equities not suffering those handicaps, were consistent, positive delivers over the whole month. Even China, where fresh lockdowns occurred, achieved a good positive outcome. Japan, similarly delivered. Our preference for long-term themes also paid off in August with cybersecurity and healthcare the leaders.