Market Watch September 2022

Macro Update: After 700 bps Rate Hikes Global Markets Tumble

The latest mini rate hiking cycle has brought us more than 700 basis points higher policy rates in developed countries. The Swedish risk bank has surprised with a 1% step while the Bank of England has  disappointed with a too small step of 0.5%. Also, the Fed has increased less than market participants have expected.

They have sent out a clear message that much higher policy rates are needed, and they are willing to accept that the economy will fall into a recession before inflation falls back to an acceptable level.

The final news which has initiated a further sharp rise in yields globally and a strong depreciation of the pound was the communication of the mini-UK–fiscal-budget.

Market participants state that the Modern monetary theory (MMT) does not work! The MMT says that governments create new money by using fiscal policy and that the primary risk once the economy reaches full employment is inflation, which can be addressed by gathering taxes to reduce the spending capacity of the private sectors. But the UK has already high inflation and reduces taxes, meanwhile the BOE raises rates and buys now even bonds at the same time. Or as UBS has put it: this is ‘Hogwash’ (i.e., rubbish).

Current market conditions can trigger a forex change  crisis and pushes the global economy further into a (deep) recession.

However, recent PMI data from the US and China do show some sings of a stabilization or even a recovery from low levels. Differently in Europe – all soft economic indicators are pointing towards a strong recession. Meanwhile, in the UK we might see not only inflation far above 10%, but also a sharp slow down of its economy due to the negative effects of Brexit and the possible sharp rate hike of the BOE. The UK regulator had to react to the market turbulences and has announced to delay its QT (Quantitative tightening) until the end of October and it will buy unlimited long dated UK government bonds. That is a clear sing of weakness and will put more pressure on the pound and create more inflation.

There are only two large countries which still have a loose monetary policy. In Japan the Yen has as a consequence fallen sharply and inflation has risen above 2.5%. In Turkey the currency continues to weaken and inflation stays above 80%.

It becomes now clear that inflation is here to stay until central banks communicate to bring it back down to around 2-3%. For the foreseeable future government bond yields will stay below inflation and institutional investors are forced to live with negative yielding assets.

Markets in 2022: Currencies, Commodities, Equity & Bond Indices

Investment Outlook: Make or break – S&P 500 at a pivotal level

Liquidity

The CHF has continued to strengthen against most currency pairs. Only against the dollar we see a roller coaster.

The EUR has dropped like a stone against the USD only to be outpaced by the pound. In both cases, central banks are accelerating the trend although they have hiked rates, but both are hiking less than expected.

The USD measured by the DXY Index has over the last weeks sharply risen due to the hawkish fed rate outlook and the poor policy reaction from the ECB, BOE or BOJ. We should see a consolidation but would still expect higher index levels over the coming weeks.

Equities

The S&P 500 has not overcome its 200-day average and has since then fallen back to recent seen year lows. We are now again at a pivotal level. Short-term a rebound could happen, but mid-term the risk for going below 3600 is very high.

The US market trades above 15 times PE ratio, which is at least 3 points too high for a recession phase and an environment where the fed rises its policy rate. Earnings estimates are still too high so that the PE ratio is distorted.

Europe trades below ten times PE and looks attractive, but due to the weak economic outlook and still to high earnings estimates we prefer Swiss or US equities. But it is still too early to buy the dip.

Fixed Income

Since the last fed rate decision US 10-year treasury yield has risen temporarily above 4%. But that impressive move was outpaced by the 2-year yield rise. We see a significant inversion of the US yield curve. The spread between the 2Y and 10y has fallen to minus 0.27%, such levels below zero have since the eighties always let to a recession.

Turning to the UK where we see that yields have risen faster and stronger than in the US due to a too small rate hike of the BOE and the new UK mini-fiscal-budget. That has triggered a selloff in government bonds and a depreciation of the pound by more than 10% in less than a week. The BOE has announced to temporarily buy unlimited UK Gilts (10-year government bonds) to calm down the situation. But we fear inflation will surge due to this contradicting actions.

Alternative Investments

The Gold price has fallen from around 1720 to below 1630 per once after the recent strengthening of the US dollar and the rise in global government bond yields. We expect that gold continues to trade range bound if government bond yields keep rising.

Copper has been falling from around 8000 to 7350 due to recession fears. Due to a weaker global growth outlook we expect only modest gains over the coming months but would still see higher prices mid-term due to an expected increase in demand triggered by the green revolution.

Both oil futures have been trading with high volatility. Due to a worsening economic outlook, we see now WTI trading below 80 USD and Brent at 86 USD per barrel. There is still a shortage of production if we exclude the Russian oil supply but that gets neglected by market participants. As long as risky assets keep falling and the economic news flow does not improve, we would expect that oil prices won’t significantly rise.

Investments covered

Ford Motor Company, 7.5%, 2026

Hilton Domestic Operating Company Inc., 4.875%, 2027

Nvidia Corporation

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