Weekly multi-asset update | Insight Investment

Summary

• Risk appetite returns to markets with equities rallying and bond yields moving higher.
• Fed fund futures indicate a cut in rates before year-end.
• UK food price inflation higher as Bank of England (BoE) Governor warns interest rates would likely need to rise further.
• Eurozone headline inflation falls markedly in March, but core inflation rises.
• Next week focus turns to the US labour market and further PMIs.
• * We will be taking a one week break for this weekly update. The next will be on 17^th April.

Weekly review

Risk appetite returns to markets with equities rallying and bond yields moving higher

Equities picked up over the week as concerns about the stability of the banking sector started to diminish and hopes increased that interest rates were close to peak levels. Markets were also encouraged by promising economic data, notably improved consumer confidence indicators in both the US and Germany, and lower-than-expected inflation of 6.9% for the eurozone in March, down from 8.5% in February. All major markets moved higher. European equities were strongest, with the Euro Stoxx 50 outperforming the FTSE 100 and S&P 500 indices. The Nasdaq index hit its highest level since late August as technology shares recovered. After the recent turmoil in financial markets which saw bond yields dropping significantly in a short space of time, yields recovered over the week as relatively benign conditions prevailed. The 10-year Treasury yield climbed approximately 20bp to 3.6%, while the two-year yield rose 30bp to 4.1%. Bond yields also rose in the UK and Europe, with short rates rising more than long rates, as investors began to focus again on the risks of inflation rather than recession.

Fed fund futures indicate a cut in rates before year-end

Fed fund futures currently suggest that interest rates will fall to approximately 4.3% at year end, down from its current 4.75-5.00% range, although this is above the sub-4% level that was being priced in earlier in the week. Additionally, the two-year Treasury yield has fallen by approximately 100bp from its 16-year peak in early March. The steepening of the yield curve has been remarkable over the past three weeks, led by a fall in short rates as investors increasingly expect the Federal Reserve to hold off on rate hikes. The yield gap between two-year and 10-year Treasuries has narrowed by approximately 60bp over three weeks, although it remains negative. Nevertheless, the Fed insists rates are likely to rise before it is in a position to cut – something that it does not foresee this year at all, despite many market commentators continuing to highlight the risk of a recession in the US, as monetary conditions and the terms of credit extended by banks tighten.

UK food price inflation higher as Bank of England (BoE) governor warns interest rates would likely need to rise further

Food prices rose to 15% year on year in March, up from February’s 14.5%. Fresh food prices were the main driver, rising by 17%. Poor weather, both at home and abroad, have led to shortages of certain common products and pushed prices higher. Including non-food items, annual shop price inflation also rose to a new all-time high of 8.9% in March.

In a speech early in the week, BoE Governor Andrew Bailey said that recent events in the banking sector would not derail the central bank’s efforts to bring inflation back under control, and that further interest rate hikes should be expected if inflation remained persistent. However, Bailey reiterated his view that headline inflation would soon fall materially and drop to the BoE’s year-end target of around 3%. Regarding the mini-banking crisis, he stated that the central bank was in a “period of very heightened, frankly, tension and alertness”, while reassuring investors that that the current flare-up is “very different” to that of the global financial crisis of 15 years ago. Later in the week, BoE policymaker Catherine Mann discussed a key challenge faced by the central bank, noting that even while headline inflation is predicted to fall notably, core inflation – driven by broader pressures from higher wages and rising prices in services – was likely to remain elevated. 

Eurozone headline inflation falls markedly in March, but core inflation rises

The headline figure dropped to 6.9%, down from March’s 8.5%. It was the lowest reading for over a year and lower than expected. However, core inflation rose over the month to 5.7% from 5.6%, indicative of a broadening of inflationary pressures. Earlier in the week, the European Central Bank (ECB) published its March economic bulletin. The central bank updated its forecast for headline inflation to an average annual rate of 5.3% in 2023, 2.9% in 2024 and 2.1% in 2025. While it expects energy prices to continue to fall and ease pressure on households, underlying inflation – notably in food – will likely remain more persistent. The outlook for economic growth was also upgraded to 1.0% for this year, followed by 1.6% in both 2024 and 2025.

Next week focus turns to the US labour market and further PMIs

The US jobs report is likely to take centre stage next week as markets look for indications of a slowdown in the labour market following the 475bps of tightening from the Fed over the last year. This is the last US jobs report before the next Fed meeting on 3 May and comes in the wake of recent strong nonfarm payroll beats, a hot inflation print, and a 25bp Fed increase despite broader concerns on the banking sector. Over in Europe, key reports include the trade balance, factory orders, and industrial production for Germany, industrial production and the trade balance for France as well as retail sales and PMIs for Italy. There is also plenty of economic data releases in Asia next week including China’s Caixin PMIs for manufacturing and services.

Summary

• UBS steps in to purchase Credit Suisse, market surprised by treatment of AT1 bonds.
• Financial conditions tightening in the wake of recent turmoil, but Federal Reserve continued to raise rates.
• Inflationary prints in the UK and Japan continue to rise; Bank of England follows Fed and hikes 25bp.
• Next week is a relatively light week following central bank meetings; a focus on US and European inflation prints.

Weekly review

UBS steps in to purchase Credit Suisse, market surprised by treatment of AT1 bondholders

In moves reminiscent of those made during the GFC or Euro sovereign crisis, the purchase of Credit Suisse by UBS was announced over the weekend.  Although the initial market reaction was negative, judging by UBS’ share price fall of 18% on Monday morning, this quickly reversed as investors digested the favourable terms offered to UBS by the Swiss authorities. Indeed, the UBS share price gained on the day.  While investors were initially reassured by the quick resolution, concerns regarding the financial viability of US regional banks and the impact a banking crisis might have on economic growth weighed on sentiment.  Investors started to search for the next “shoe to drop”. There was also some lingering shock at the treatment of certain bonds, namely the total write-down of Credit Suisse’s AT1 (Additional Tier 1) bond holders, even though shareholders (technically a lower ranking part of a company’s capital structure) received some compensation. The European Central Bank (ECB) and Bank of England (BoE) were quick to try to reassure investors that this principle would not apply in any eurozone or UK bank failures. However, it did offer investors a stark reminder that in times of stress the rules can easily be rewritten.

Financial conditions tightening in the wake of recent turmoil, but Federal Reserve continued to raise rates

The Fed raised interest rates by a further 25bp, taking the policy rates to 5.0% – its highest level since September 2007 – and marked the ninth consecutive hike. The tone of Fed Chairman Jerome Powell’s accompanying statement was more dovish than in recent months. Instead of reiterating the need for further interest hikes as he had done at the last meeting, Powell said that “some additional policy firming may be appropriate”. While he reaffirmed the Fed’s determination to bring inflation back under control, he also suggested that the recent banking sector upheaval may tighten bank lending standards which may dampen growth and inflation. The market is now pricing in only a 50% chance of a rate hike in May, with 1.5% of rate cuts priced in by year end.

Inflationary prints in the UK and Japan continue to rise; Bank of England follows Fed and hikes 25bp

Headline inflation in Japan eased to 3.3% in line with expectations and reflecting lower utility and food prices. However, food prices have risen 7.5% YoY, the fastest pace for 43 years the level of core inflation also picked up, increasing 3.5%, the highest rate since 1982. This increases pressure on the Bank of Japan to consider changing policy over the next few months following the change in leadership. 

Inflation in the UK also picked up unexpectedly in February, as the annual rate of inflation rose to 10.4%, up from 10.1% in January and ahead of market forecasts, largely on the back of rising food prices; fresh food and non-alcoholic drinks together rose by 18% YoY – the steepest increase for 46 years – while fuel and energy costs continued to ease. Meanwhile, core inflation (excluding energy and food) also accelerated, rising by 6.2%, compared with 5.8% in January, in a sign that inflationary pressures have broadened. The reacceleration in the UK’s inflation contrasts with falling pricing pressures in the US and the eurozone.  The Bank of England announced a 25bp rate hike taking the benchmark rate to 4.25%.  Although it stated that it expects inflationary pressure to ease in the future, the central bank noted that it would tighten policy further if pricing pressures did not abate.  However, the BoE did raise its economic outlook for 2023, with the UK on course to avoid a technical recession with Q2 GDP expected to increase rather than contract. 

Next week is a relatively light week following central bank meetings; a focus on US and European inflation prints

Next week brings several key inflationary data releases including the Fed’s preferred inflation measure, PCE, as well as inflation in Europe and an array of consumer and business confidence indicators. The PCE print follows this week's Fed decision to raise interest rates by 25 bp, with the higher CPI print perhaps serving as one of the main reasons why the central bank did not pause in the face of the banking sector jitters.  In Europe, markets will be focused on the preliminary inflation across the Eurozone as well as the German IFO survey and consumer confidence. Turning to Asia, key releases include the Tokyo CPI, labour market and industrial production. Investors in Asia will also be able to gauge the rate and scope of China's economic recovery when the PMI data is released on Friday. Given the uncertainty surrounding the US regional banks the US Treasury Secretary, Janet Yellen, has convened a previously unscheduled meeting of the Financial Stability Oversight Council, which includes the heads of the Federal Reserve, the Federal Deposit Insurance Corp. and other US regulatory bodies.

Summary

• Financial sector turmoil shifts from Silicon Valley Bank to Credit Suisse; regulators step-in to calm markets.
• Short-dated government bond yields fell sharply in response, corporate bonds underperform.
• Market expecting fewer rate hikes and potential for easier policy into H2; policymakers less convinced.
• Next week: Central bank policy meetings in the UK and US, flash PMIs to provide growth update.

Weekly review

Financial sector turmoil shifts from Silicon Valley Bank to Credit Suisse; regulators step-in to calm markets

Concerns about the viability of Credit Suisse took centre stage this week as markets were still digesting the collapse of Silicon Valley Bank (SVB) and Signature Bank – the second and third largest bank failures in US history. Share prices in the banking sector were materially hit as a result, with other risk assets falling in sympathy. Credit Suisse’s auditor had issued an “adverse opinion” on the bank’s report and accounts, which, combined with a falling share price, perceived challenges for the bank in raising additional capital. A lack of visibility on deposit flows further spooked investors. The Swiss National Bank was forced to provide a CHF50bn loan facility to help provide liquidity which helped to reassure investors, but much uncertainty as to the longer-term viability of the bank remains. 

The market remained concerned about potential contagion, with a group of large US banks agreeing to provide funds to the stricken First Republic Bank in a move to provide additional confidence to a market that still bears the scars from the GFC.

Short-dated government bond yields fall sharply in response, corporate bonds underperform

Global bond yields plummeted in the wake of the SVB and Credit Suisse news; investors priced in a softer monetary policy stance from the Federal Reserve and other major global banks as the mood in markets darkened. The two-year US Treasury yield dropped approximately 60bp – the most in a single day since October 1982 – to just over 4.0% on Monday, leading to a substantial steepening of the yield curve as longer-dated bond yields fell only moderately. The German two-year Bund yield fell dramatically – by almost 50bp – the steepest drop for 33 years.  By contrast, corporate bond spreads widened dramatically in both physical and synthetic credit markets, with both investment grade, and high yield spreads wider on the week.  In the US, the CDS index for investment grade bonds rose towards 100bp, its highest level for four months, reflecting fears of banking contagion.

Market expecting fewer rate hikes and potential for easier policy into H2; policymakers less convinced

Markets started to price in a lower terminal rate for central banks, with a series of cuts now priced in the US in the second half of the year.  Policymakers were less convinced, with central banks facing the twin concerns of above-target inflation and a financial sector under stress.  Given that the issue this time appears to be more one of confidence (certainly for Credit Suisse), it may be that policy measures, such as liquidity provision, are used to support the banking sector while policy rates remain on an upward path to try to contain inflationary pressures. This was certainly true for the ECB, which pressed on and raised interest rates by 50bp, surprising some investors that felt the market volatility may lead the ECB to reduce or even delay a rate hike entirely. The ECB did revise its 2023 forecasts, with core inflation up to 4.6% and GDP up to 1.0%.  ECB President Lagarde abandoned specific guidance on interest rates and stated that further changes in rates would be “data-dependent”, a recognition that financial conditions may be tightening given the market volatility.    

Elsewhere, the UK government announced their latest “budget for growth”, which, together with slower growth, led to the UK Debt Management Office announcing c.£240bn of UK gilts sales (up from £169bn this year). This is a substantial amount of issuance at the same time as the Bank of England will be looking to sell its gilts purchased under its asset purchase scheme (QE).

Next week: Central bank policy meetings in the UK and US, flash PMIs to provide growth update

Aside from any further news from the banking sector, next week also brings the Federal Reserve and the Bank of England back into the spotlight as they deliver their latest monetary policy decisions on the back of a tumultuous week in markets. It is widely anticipated that both central banks will hike rates by 25bp. The Fed will also provide its Summary of Economic Projections; an update on its view on growth, inflation and policy rates. The BoE is expected to provide dovish forward guidance amid concerns over risks that it may overtighten policy. Next week also brings key data releases, including global flash PMIs, housing market data, CPI in Japan, Eurozone consumer confidence and PPI in Germany.

Summary

• Equity markets fall as worries about the outlook for inflation resurfaces.
• Federal Reserve reaffirms the case for tight monetary policy.
• The European Central Bank (ECB) warns of higher rates.
• Next week: US CPI, European Central Bank (ECB) policy decision and economic data from China.

Weekly review

Equity markets fall as worries about the outlook for inflation resurfaces

Global markets weakened following Federal Reserve Chairman Jerome Powell’s testimony to Congress, in which he poured cold water on previous hopes that the pace of rate hikes might slacken and instead focused on how ‘sticky’ inflation had become. The S&P 500, FTSE 100, and EURO STOXX 50 indices all fell a couple of percent as Treasury bond yields surged and the market began to discount higher rates. Bank stocks were hit badly in the US and Europe after SVB Financial, a US technology specialist financer, tried to launch a share issue to plug its balance sheet following bond-related losses. Commodities declined in aggregate over the week. Oil prices fell about 6% as traders worried about the impact of higher interest rates on demand. Copper fell for a similar reason, while gold also eased partly due to the strengthening US dollar.

Federal Reserve reaffirms the case for tight monetary policy

In testimony to Congress, Fed Chair Jerome Powell was adamant that the battle against inflation was far from won. He admitted the Fed had been surprised by the strength of recent economic data and that rates may need to rise above current market forecasts to bring inflation back under control. “The ultimate level of interest rates is likely to be higher than previously anticipated,” he said. The 10-year Treasury yield touched 4% following his speech, while the two-year yield broke above 5% for the first time in 16 years, leaving the inversion between 10-year and two-year bonds at over 100bp, its highest negative spread in 41 years. Yields eased a little in the latter half of the week as Powell appeared slightly more dovish on the second day of his testimony. Nevertheless, the odds on a 50bp hike this month have hardened, with consensus expectations hovering at just above 40bp from 25bp a few weeks ago. However, yields eased after Powell appeared slightly more dovish on the second day of his testimony, and initial jobless claims rose.

The European Central Bank (ECB) warns of higher rates

ECB President Christine Lagarde and some other senior ECB members agreed that the market should expect further hikes in interest rates. Describing inflation as a “monster” that needs to be “knocked on the head”, Lagarde was at pains in an interview during the week to state that inflation was too high and that further rate hikes were essential. Indeed, with core inflation rising to a new record high last month of 5.6%, expectations of peak rates in the eurozone have increased to above 4%. Eurozone bond yields climbed, especially at the short end. The German two-year bond yield rose above 3.3%, its highest level for 15 years, taking the inversion with 10-year Bund yields to nearly 70bp, its most inverted for over 30 years and approximately double the level from a month ago. Yields declined a little later in the week on a favourable ECB inflation survey which showed consumer expectations of inflation in January beginning to fall.

Next week: US CPI, European Central Bank (ECB) policy decision and economic data from China

The most anticipated data release next week is the US CPI report on Tuesday. Given the upside surprise in January report , next week's data will be critical in determining whether it was a blip in a disinflationary trend or indications of more persistent than expected inflation leading up to the 22nd March Fed meeting. In Europe, the spotlight will be on the ECB decision on Thursday, with the market currently pricing in an increase of 0.5% to the base rate. The meeting comes with high inflation figures throughout the EU, as well as generally stronger-than-expected economic performance. In Asia, China's retail sales and industrial production data is due to be released.

Summary

• Inflation surprises to the upside in Europe; European Central Bank (ECB) maintains its hawkish stance.
• Bank of England (BoE) strikes a more moderate tone, despite significant food price inflation prints.
• Inflationary concerns and hawkish central banks pushed bonds lower, equity markets relatively resilient.
• Next week: US jobs data likely to dominate economic releases; start of China’s National Party Congress.

Weekly review

Inflation surprises to the upside in Europe; ECB maintains its hawkish stance

Eurozone inflation fell for the fourth successive month, with headline inflation falling from January’s 8.6% to 8.5%. However, this was significantly above expectations (consensus 8.2%) and reinforced the hawkish tone from ECB speakers. While the pace of energy prices declined, food price inflation accelerated. Meanwhile, core inflation hit a new all-time high of 5.6% during the month, up from 5.3% in January, although this was, to some extent, presaged by the increase in both French and Spanish inflation earlier in the week. The minutes from the January ECB meeting were released and revealed a hawkish mindset. The ECB indicated that it will likely continue to raise rates beyond March as it was “much too early to declare victory” over inflation. Policymakers still believe that the risks to inflation are on the upside and there is currently little danger of over-tightening given the surprising resilience of the economy. This points to a potential scenario of keeping rates ‘higher for longer’. The market is now pricing the terminal rate for ECB policy rate to close to 4%, a further 150bp of rate hikes, up about 50bp over the month.

Bank of England strikes a more moderate tone, despite significant food price inflation prints

In a speech during the week, BoE Governor Bailey suggested that the bank could be close to the end of its tightening phase, a stark contrast with the more hawkish tone from other central banks. Bailey appeared to be more sanguine on the outlook for UK interest rates, stating that further rate hikes were not inevitable, but also making it apparent that nothing was settled yet. This partly reflects the view that there will be relief for UK households in the coming months from falling energy bills as the recent drop in natural gas and oil prices begins to become more apparent, and that this will lead to a steady fall in headline inflation. Slowing inflation wasn’t reflected in food prices, however, as estimates for a c.15% increases over the month with scarcity of fresh goods a key driver. The initial reaction to Bailey’s remarks was a fall in UK government bond yields and a weaker sterling, although the former reversed course over the rest of the week, with 10-year gilt yields ending up at 3.9% following the food price data and global market moves.

Inflationary concerns and hawkish central banks pushed bonds lower, equity markets relatively resilient

Indeed, global bond markets continued to sell-off over the week, resulting in the weakest bond market return in February since 1981. This was sparked by the strong personal consumption data out last week in the US but was then supported by the above expected inflationary pressures in the US and Europe. 10-year US Treasury yields broke through 4.0%, the highest level since November, while the two-year yield hit a 16-year high of 4.95%, taking the spread between the two bonds to its lowest point this cycle and a multi-decade low of almost 90bp in mid-week. A similar pattern was evident in eurozone bond markets.

Global equities, however, were slightly more resilient and took encouragement on Thursday from a more dovish tone struck by a Federal Reserve policymaker who recommended the Fed raise rates by just 25bp this month. The S&P500 broke through into mildly positive territory, while the FTSE 100 and Euro STOXX 50 both rose and outperformed the US market.

Next week: US jobs data likely to dominate economic releases; start of China’s National Party Congress

The US jobs report and Fed Chair Powell's congressional testimony before House and Senate committees are likely to take centre-stage next week. Given that the previous non-farm payroll came in well ahead of expectations at 517,000 and the latest CPI print showed stickier-than-expected price pressures, we believe the decisive factor will be whether the jobs report continue to surprise on the upside and thus put additional pressures on the hawkish rhetoric. In Europe, the focus will be on the UK once the monthly GDP report is released on Friday, ahead of the BoE meeting on 23 March. The ECB will also release its consumer expectations survey, following this week’s upside surprises in European inflation reports. Over in Asia, markets will closely follow China’s 14th Nationals People’s Congress (NPC) as China navigates the quick abandonment of the zero-COVID strategy, swift economic recovery and geopolitical tensions. Following the NPC, attention will also be on February's inflation figures, notably the CPI and PPI data due on Thursday. In Japan, next week is Governor Kuroda’s last monetary policy meeting, with votes on the nominees for governor and duties expected to take place on Thursday and Friday.