Week ended June 16, 2023: Risk-rally broadening
As expected, the Fed chose to pause its rate increases following 10 consecutive FOMC meetings dating back to March 2022. In contrast, the ECB carried on with its well-telegraphed increases. Both rates decisions were followed by press conferences featuring each respective head, and – as usual –these exchanges provided better insights as to each committee’s forward thinking vis-à-vis the carefully-crafted and rather terse press releases. (As an aside, the Bank of Japan did absolutely nothing at its monetary policy meeting on Friday.) For reasons not entirely clear (at least to me), the risk rally broadened off the back of these important central bank decisions.
As I wrote last week, the Bank of Canada and the RBA – both of which resumed their rate increases following a pause – opened the door to the Fed’s unconventional approach, a sort of optionality that the Fed now has made crystal clear it possesses. The May CPI read on Tuesday before the FOMC rate decision further paved the way for a pause, although the talking Fed heads had largely laid the groundwork already. In spite of the decision to pause, core CPI is proving difficult to rein in – this key measure of inflation has increased 0.4% or more each month since December 2022. The ECB on the other hand was not wishy-washy at all, raising its three key bank rates a further 25bps with further increases “pencilled in”. The ECB has committed to carrying on with its tightening regime until inflation in vanquished. Surprisingly robust April GDP data released mid-week by the UK’s ONS almost certainly guarantees that the Bank of England will follow suit and continue hiking its Bank Rate, with the next decision slated for June 22nd. Here's the bank rate migration of the Fed, the ECB and the BoE from the FT.
There is more of my gibberish about these decisions in the section further below “What happened this week that mattered?”, but before I lose your attention, let’s quickly look at the effect of these policy decisions on financial markets.
MARKETS THIS WEEK
The overall reaction to this week’s economic data was most visible in two markets: currencies and equities. With the Federal Reserve pausing and the ECB barrelling ahead with its rate increases, a sequence that the Bank of England is likely to follow this coming week, the US Dollar lost ground against both Sterling ($1.282/£1.000, USD down 2.0% WoW) and the Euro ($1.094/€1.000, USD down 1.8%). A weaker US Dollar has knock-on effects into commodity prices, too. Currency gyrations were a sideshow though to the risk-on attitude that is gripping global equities at the moment, with the S&P 500 racing ahead to close at its highest level on Thursday in 14 months. Most “real money” investors seem to realise that this is getting out of hand. However, hedgies and similar fund managers that are effectively index benchmarked, sitting on the side lines in cash waiting for the “big correction” that has yet to come, are getting further and further behind as stocks roar forward and the rally broadens. FOMO-driven retail is adding to this broadening technical rally, jumping in with both feet, seemingly oblivious to underlying fundamentals but keen on not being left further behind. I can’t help but pontificate – invest your money for the long-term and only trade around the edges, because being in cash during periods of big gains is more costly than most people ever realise. Interestingly, the nexus of a weaker Dollar and strong risk-on sentiment in equities is most visible in emerging markets equities, which have had a very nice June run indeed. Here are some other highlights from the week:
Global equities are on fire, with all of the indices I track higher WoW. Outpacing most indices by a long shot are the “cheap money” fuelled gains in the Japanese stock market (Nikkei 225 +4.5% WoW, +29.2% YtD), and the concentrated gains in the tech-heavy NASDAQ Composite (+3.2% WoW, +30.8% YtD).
Bonds took it on the chin at the short end of the curve in the US, (2y yield +11bps WoW), the UK (2y Gilt yield +34bps WoW) and the Eurozone (2y Bund +21bps WoW) this week. The 2y-10y UST yield curve inversion is back above 90bps for the first time since the bank crisis in early March, signalling slower economic growth ahead.
Corporate credit spreads tightened further in both investment grade and non-investment grade. Perhaps most indicative of the risk appetite of credit investors at the moment, the spread on the CCC-rated ICE BofA rated index fell below 10% for the first time since early February, suggesting limited investor concerns around corporate credit.
Are you thinking “what should I do?” It’s a tough call, but were I all in cash now, I would dip carefully and slowly into equities in the value / beaten down sectors, and in defensive stocks that might be most resistant to a period of slower earnings growth influenced by slower economic growth. Higher tier corporate bonds are worth a look, and of course, UST yields haven’t been at these levels in many years. Keep cash available, and use any potential correction – should such a correction eventually arrive (and I suspect it will) – to average down your cost basis. For those of you that have gotten to know me, you know I am always well long stocks, although I must admit my cash / UST positions are higher than they have ever been. Raising this cash has come at an opportunity cost, having dumped winners like LLY and NVDA too soon, which is why I often regret selling stocks of companies in which I have conviction, valuation-aside.
If you would like to see details by asset class / market type, go to “The Tables” further below.
WHAT HAPPENED THIS WEEK THAT MATTERED?
The FOMC decision this week was as expected, as the Fed stopped its rate rises for the first time since March 2022, which had included 10 consecutive meetings (press release here). However, also as expected, Mr Powell and co left the door open to future tightening of monetary policy should inflation not be heading towards the targeted 2% quickly enough. The Fed chair reiterated the Fed’s philosophy at the press conference following the FOMC meeting (on YouTube here), although the “wordsmithing” seemed confusing at times to me. The combination of market forward indicators and revised economic projections from the Fed, also released on Wednesday, suggest no reduction in the Fed Funds rate this year. In fact, the infamous “dot plot” suggests that there could be two further 25bps rate increases in the Fed Funds rate in 2023, followed by a decrease towards the 4-3/8% to 4-5/8% area in 2024. Fed forecasts also project a soft landing with unemployment peaking in the mid-4% area (in 2024) before starting to decline, and PCE inflation drifting slowly back towards its 2%/annum target by 2025. The projected year-end peak of the unemployment rate was reduced in the newer forecasts (vis-à-vis the March forecasts) from the high 4% area to 4.1%, showing that the Fed’s expectation of economic pain would be modest. If you want to dig deeper, take a look at the “Summary of Economic Projections”.
Following the FOMC decision on Wednesday, the ECB delivered its monetary policy decision the following day, raising its trio of bank rates by a further 25bps (to 3.50% for the benchmark deposit rate). The ECB went on to say that rates would be “brought to levels sufficiently restrictive to achieve a timely return of inflation to our two per cent medium-term target and will be kept at those levels for as long as necessary.” President Lagarde was significantly less wishy-washy than Mr Powell, almost pencilling in a further increase in benchmark rates at the late-July ECB meeting to ensure that inflation is vanquished. In addition, the ECB announced it would end its refinancing of maturing securities in its Asset Purchase Programme (“APP”), now €15 bln/month, starting in July, effectively accelerating its quantitative tightening as far as the APP. The pandemic emergency purchase programme (“PEPP”) will continue refinancing all of its maturing assets through the end of 2024. See “Combined Monetary Policy Decisions and Statement” here.
UK growth figures for April surprised on the upside, with preliminary figures indicating that GDP rose 0.2% in April (MoM) compared to a decline of 0.3% in March (MoM) – see “GDP monthly estimate, UK: April 2023” from the ONS. Not surprisingly as we are seeing in the US and EU, services continue to lead the charge, offsetting lethargic manufacturing and construction sectorial growth. I cannot begin to try to explain the swings in monthly growth in UK GDP in the chart below, which is straight from the ONS statement.
Better-than-expected April growth led to a reminder from Jeremy Hunt, Chancellor of the Exchequer, that the current Conservative government under the leadership of PM Sunak would do everything in its power to reduce inflation. This implicitly sets the stage for a further 25bps in the Bank Rate by the Bank of England this week, almost a certainty given persistently high UK inflation. And like the ECB, it is doubtful that this will be the last such increase.
The Bank of Japan is sticking with its ultra-loose monetary policy in a decision announced Friday, providing further fuel for the rally in Japanese equities as the Yen gets clobbered. This has to be the most insular central bank and economy in the world, bucking the tightening regime of its G7 peers even as Japanese core inflation increases to levels not experienced in years, as you can see in the graph below (change in core CPI YoY from tradingeconomics.com).
Here is the Bank of Japan’s “Statement on Monetary Policy” from June 16th.
The tables below provide detail across various global and US equity indices, the US Treasury market, corporate bonds and various other asset classes.
Corporate bonds (credit)
Safe haven and other assets