Market commentary

The beginning of 2023 has been eventful. January was characterised by a renewal of risk appetite as investors decided that their worst expectations for economic growth in the United States, Europe and China were not going to be met. This was helped by a growing view that the peak for inflation was behind us, which helped to bring down peak interest rate expectations and bond yields.

Fast forward to February, and the mood had changed. Higher-than-expected growth has led to a perception that inflation is going to prove stickier than forecast. This has led to another rise in bond yields and to the pricing in of a “higher for longer” interest rate environment, especially in the US and Europe. This has, in turn, had a depressing effect on equity market valuations, with the US seeing some big falls, reversing some of the gains for January.

March has continued the bad news and equities were sharply lower last week as the global banking sector suffered in the aftermath of Silicon Valley Bank’s failure and pressure on a number of other banks, notably Credit Suisse.

We have discussed the detail of the Spring Budget elsewhere but the Chancellor has benefited in the run up from a more benign economic environment – confidence globally since November’s mini-Budget has improved materially and UK growth forecasts for this year and next have been upgraded. Although the economy is expected to shrink in 2023, the Office of Budget Responsibility (OBR) no longer think the UK will enter a technical recession this year (i.e., two consecutive quarters of contraction).

The emphasis on company investment, and getting people back to work, either through providing childcare (in time) or bringing people back from early retirement is designed to provide stimulus to the economy. They are far from a silver bullet to ease the economy’s woes, but the endgame will be to find headroom in the finances for a tax giveaway ahead of a likely 2024 election.

The region benefitted enormously from a mild autumn and early winter, which meant that stockpiles of natural gas were more than sufficient to see it through. There was growth in the eurozone over the year, which was a good performance given the effects of Russia’s invasion of Ukraine and Europe’s dependence on supplies of key commodities, such as oil and gas from the region. Rapidly falling gas prices helped this outcome but money available from the EU Recovery Fund, a legacy of the Covid pandemic, has also helped.

The most notable market shift last week was again in US interest rate expectations. With US inflation coming in as expected at 6% there was some relief, with the expectation being if inflation proved stronger than expected it could mean further unanticipated interest rate rises.

The banking crisis has, in the short term caused a fall in interest rate expectations and bond yields. The behaviour of banks will now be more cautious in who they lend to and this should in time lead to lower economic activity and the chances of recession. This is currently being priced in by company valuations, leading to the stock market falls we have been seeing

All eyes remain on China, not only for its influence on Emerging Markets, but also for what its recent Covid policy changes might mean for the broader global economy with the possibility of a reopening ‘boom’ both from increased supply and also spending in China itself.

Tensions between the US and China are rising following the spy balloon incidents and could rise further still given US concerns over the possible supply of Chinese armaments to Russia.

As already discussed, in February central bank speakers have been firmly emphasising their inflation-busting credentials with threats not only to raise interest rates higher, but to leave them there for an extended period.

In the US, the market-derived forecast for the peak in interest rates was 4.91% at the end of January. By the end of February, it had risen to 5.41%, a substantial 0.5% increase. Perhaps more tellingly, there was an even bigger shift in expectation for January 2024. That figure rose from 4.27% to 5.16%, almost a full percentage point higher.

There were similar moves on this side of the Atlantic, notably in Europe, where inflation rates for February came in higher than expected in Germany, France and Spain.

As for the Bank of England, it has been difficult for it to fight the trend towards higher rates in most developed market economies. However, on Wednesday 1 March, the Bank’s Governor, Andrew Bailey, pushed back strongly on market-based projections for further increases, stating that the Bank of England had shifted from its previous stance that ‘further increases in the bank rate would be required’.