Welcome to the latest episode of my monthly YouTube show where I discuss what is happening in investment markets and what to look out for. This episode I explain why investors must keep one eye on the situation in the Middle East but with the other eye still firmly focused on economic data, bond yields, the US dollar and the outlook for central bank policies around the globe.
Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.
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Abridged transcript - Damien's Market Update - October 2023
If you recall my last market update was titled “Goldilocks Returns” but as September progressed, the initial optimism of investors, who had been banking on the Goldilocks narrative in the US, began to wane. The hope for an economy that could gracefully sidestep both a recession and aggressive rate hikes was beginning to be put to the test. Strong data from the US services sector and the looming spectre of higher inflation began to sow doubts about the Federal Reserve's future ability to hold off increasing Interest rates further.
The situation wasn’t helped by an IMF paper released during this period which shed light on the historical persistence of inflation, especially after terms-of-trade shocks (I won’t go into a full explanation here as I cover the topic in detail in episode 432 of the Money to the Masses Podcast). In short, the report emphasised that in many historical episodes, initial signs of declining inflation were misleading, often leading to premature policy easing. This insight from the past underscored the challenges central banks face today, suggesting that consistent and tight monetary policy is crucial (and therefore likely) in addressing high inflation.
The current surge in the price of oil has also further complicated the landscape, especially given that one of the historic scenarios analysed by the IMF was that of the oil price shock in the late 1970s which was followed by a second wave of inflation. Higher oil prices, combined with a rallying US dollar, which surged to new 2023 highs, exerted additional pressure on stock markets particularly in the US and emerging markets as we headed into October. However, the UK's FTSE 100 found some respite, benefiting from the higher dollar and surging oil prices due to its exposure to oil stocks and companies with US dollar earnings which are given a currency boost whenever the pound falls against the greenback.
In Europe, weak manufacturing data from Germany also cast a shadow over European equities. Central bank chiefs from across the continent hinted at potential future rate hikes, adding to the prevailing market volatility. By September’s end, bond markets began to show significant shifts that further unsettled stock markets. German bund yields reached their highest levels since 2011, with similar trends observed in French and Italian government bond markets. The US wasn't immune either, with the 10-year treasury yield reaching levels reminiscent of 2007, heading towards 4.7%. This was further accentuated by a rare "bear steepening" of the yield curve, a phenomenon that often precedes economic recessions (Listen to podcast episode 433 for more info).
In summary, investors ended September with less faith in the Goldilocks narrative while becoming increasingly concerned that the only way central banks will end up taming a second wave of inflation is to keep interest rates higher for longer. The worry is that this course of action could end up being what finally crashes domestic economies. Is it any wonder that pretty much everything you owned (except cash) lost money during September. I’m talking about losses on most bonds and equities in tandem which is unusual. The silver lining for UK investors during September was that the weaker pound, particularly against the US dollar, meant that their equity losses were at least tempered.
Unfortunately, the start of October picked up where September left off, with global bond yields continuing their surge, causing further tremors in stock markets. The 10-year US treasury yield pushed to new multi-year highs, while the 30-year treasury yield hit a staggering 5% - its highest level since 2007. The German yield curve also saw significant movement, with the 10-year bund yield reaching 3%.
This aggressive bond market sell-off in 2023, especially in longer-dated bonds, is different to the bond carnage of 2022, where the sell-off was more pronounced in shorter-dated bonds, reflecting immediate reactions to central bank rate hikes back then, as opposed to the “higher for longer” fears now. Stock markets, already reeling from September's slump, faced further headwinds at the start of October. Even the FTSE 100, which had previously shown resilience, began to falter. However, there were glimpses of stabilisation as bond yields retreated from their recent highs.
But geopolitical concerns have now added another layer of complexity. The escalating situation in Israel and Gaza prompted an initial flight to safety, with investors flocking to US treasuries, driving down yields, and bolstering the US dollar. Yet, this flight was short-lived and within days, investors’ focus had shifted back to inflation, especially after US inflation data for September exceeded expectations. This unexpected data point reignited fears of further interest rate hikes by the Federal Reserve, especially given the backdrop of strong job market data.
Equity markets typically react negatively to the outbreak of conflicts, but history has shown that such downturns are often followed by rebounds. This pattern held true in the days after the initial attack on Israel with both the FTSE 100 and the S&P 500 showing signs of recovery. European equities also experienced a boost, buoyed by rumours of potential Chinese economic stimulus measures.
However, the uncertainty stemming from the Middle East situation persists. This is evident in the gold market, which saw its price rally by over 3% last Friday, reflecting investor apprehension ahead of another weekend of geopolitical unpredictability. These Friday surges were often a feature of 2022 following Russia's initial invasion of Ukraine before investors' attention moved elsewhere.
In conclusion, as we approach mid-October, investors have one eye on the situation in the Middle East but with the other eye still firmly focused on economic data, bond yields, the US dollar and the outlook for central bank policies around the globe. It's also worth mentioning that the Q3 earnings season is getting underway which is also likely to attract investor’s attention. It’s never easy being an investor but seasonality might be about to offer a helping hand. More on that next time.
