October was a tough month for most asset classes. Robust data regarding the US economy and labour market continued to suggest that the Federal Reserve will keep interest rates ‘higher for longer’. Treasury yields rose in response, which weighed on risk assets globally. Sentiment towards equities and corporate bonds was also dented by signs of economic weakness in Europe and further geopolitical concerns after an attack by Hamas on Israel led to fresh conflict in the region.
Against this backdrop, global equities declined in October and credit spreads widened. Meanwhile, gilt yields rose, albeit more modestly than their US Treasury counterparts, while German Bund yields edged lower, anchored by concerns about the eurozone economy.
Inflation & Rates
Earlier optimism about falling inflation in the UK faded somewhat in October. According to the Office for National Statistics, annual headline consumer price inflation for September was unchanged at 6.7% while core inflation (which excludes volatile components such as food and energy costs) declined marginally to 6.1% from 6.2% in August. Both of these measures were slightly above consensus forecasts. Along with strong wage growth, this reinforced fears that UK interest rates – much like those in the US – may remain elevated for longer.
The economic picture in Europe weakened further. Preliminary Eurostat data pointed to a 0.1% contraction in eurozone GDP over Q3, while the flash composite purchasing managers’ index (PMI) for October showed that business activity continued to contract. More positively, an initial Eurostat estimate showed that annual inflation in the currency bloc is expected to have fallen markedly to a two-year low of 2.9% in October, fuelling hopes that interest rates have peaked.
As expected, the European Central Bank (ECB) kept interest rates on hold at its meeting in October. While President Lagarde noted a sharp decline in core eurozone inflation during September and the weak near-term outlook for the region’s economy, she dismissed talk of rate cuts as “totally premature”.
Economic activity in Europe has slowed considerably due to low growth in Asia and restrictive monetary policy. This trend could continue – and possibly accelerate in some interest-rate sensitive sectors – if rates remain elevated and inflation falls further, resulting in higher real interest rates.
Investors remained cautious as the Fed’s ongoing higher-for-longer interest-rate narrative became more entrenched following news of resilient US labour-market data and stronger than-expected GDP growth in the third quarter (Q3).
US Treasuries were further pressured by a weak auction; this was widely seen to reflect concerns over the ballooning supply of US debt.
More positively, the Q3 earnings season got off to a good start, with FactSet reporting positive earnings surprises by 78% of companies by the mid-point, albeit against lowered estimates.
Although the Fed is far from declaring victory over inflation, the recent downtrend in price increases suggests that monetary tightening is having an effect. It has already eased the pace of its interest-rate hikes, though there is still a possibility that central bankers could hold the terminal federal funds rate for longer than expected. Inflation and jobs data suggest an increasing likelihood of a ‘soft landing’ for the US economy. As a result, we are gaining confidence in the outlook, especially as a lot of bad news appears to have been priced in by markets already.
Chinese equities struggled again in October as geopolitical tensions and rising US Treasury yields overshadowed positive domestic economic data and additional stimulus measures from Beijing.
Retail sales and industrial production beat expectations in October, while Q3 GDP surprised on the upside. However, September’s disappointing manufacturing activity provided a reality check after the official NBS PMI unexpectedly moved into contractionary territory.
Beijing announced further support for the property sector by raising the country’s fiscal deficit ratio to 3.8% (from 3%), allowing it to issue up to 1 trillion yuan (around US$137 billion) of sovereign debt. Elsewhere, the People’s Bank of China kept interest rates on hold but injected cash into the banking system to boost liquidity.
China’s lacklustre post-Covid recovery, property sector woes and geopolitical tensions have been weighing on the stock market as a whole. However, we have noted improving policy visibility and the market was buoyed by China‒US dialogue ahead of the meeting between President Xi and President Biden. The Chinese authorities are expected to continue their support for the economy through prudent monetary policy and positive fiscal measures.
Matt Rees, Multi Asset Portfolio Manager, Columbia Threadneedle Investments
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