Market Analysis Aug 2023

In early August, credit rating agency Fitch downgraded the US government's credit rating from AAA to AA+, citing unsustainable debt and deficit trends, along with increased political discord. While this decision sparked heated debates in political and economic circles, it had a limited impact on 10-year US Treasury yields, which saw only a marginal increase after Fitch's announcement. However, yields did rise later in the month on the back of better-than-expected economic data and strong issuance.

Overall, incoming economic data remained robust in the US. July's labor market data indicated a cooling but still strong job market, with 187,000 payroll job gains, slightly below the consensus expectation of 200,000. Unemployment dipped to 3.5%, while average hourly earnings slightly exceeded expectations at 4.4% year-on-year. In July, retail sales surged by 0.7% month-on-month, well above the anticipated 0.4% increase.

On the inflation front, the headline Consumer Price Index (CPI) saw a slight uptick in July, reaching 3.2% year-on-year due to higher food and energy prices, while core CPI modestly decelerated from 4.8% in June to 4.7% year-on-year. Despite this, the minutes of the Federal Reserve's (Fed) July meeting revealed that most officials remained concerned about inflation, keeping the door open for additional rate hikes if necessary. Unlike last year, Jerome Powell's Jackson Hole speech was well-received by financial markets. In sum, the Fed's policy will remain data-dependent with a leaning towards tightening if required.

Market expectations suggest the Fed may execute one final rate hike by the year's end, followed by four or five rate cuts in 2024. The August purchasing managers' indices (PMIs) supported this dovish outlook as both manufacturing and services PMIs fell to 47 and 51, respectively.

Eurostat's preliminary GDP estimate for the euro area indicated a 0.3% quarter-on-quarter growth rate in Q2 2023. While this pace was relatively moderate, the euro area's labor markets remained tight, with the unemployment rate reaching its lowest level on record at 6.4% in June. However, economic uncertainties persisted, with the August composite PMI declining to 47, its lowest level since 2012, excluding the Covid period.

Eurozone headline inflation defied expectations, remaining steady at 5.3% year-on-year in August. Core inflation, on the other hand, slightly dipped from 5.5% year-on-year in July to 5.3% year-on-year in August. While showing improvement, inflation still significantly exceeded the European Central Bank's (ECB) target, leading markets to continue pricing in further ECB rate hikes by year-end.

The MSCI Europe ex-UK index recorded a 2.2% drop in August, primarily due to a slump in the banking sector following the Italian government's announcement of a tax on banks' "excess" profits. European bond yields remained relatively stable in August, with the Bloomberg Euro Aggregate gaining 0.3% during the month.

In the UK, the Bank of England (BoE) raised its policy rate by 25 basis points at the start of August, bringing the Bank Rate to 5.25%. The BoE emphasized its intent to maintain rates at restrictive levels for an extended period. Despite this tightening monetary policy, the UK economy pleasantly surprised during Q2 2023, expanding by 0.2% quarter-on-quarter, surpassing the consensus expectation of 0.0% quarter-on-quarter.

UK headline CPI moderated as expected, falling to 6.8% year-on-year in July from 7.9% year-on-year in June. Labor market data showed robust growth in regular pay (excluding bonuses) at 7.8% year-on-year for the April to June 2023 period, the highest rate since records began in 2001. Against this backdrop, markets continued to anticipate further rate increases from the BoE this year. Consequently, the 10-year Gilt yield rose by 5 basis points to 4.4% in August, while the FTSE All-share underperformed its developed market counterparts, declining by 2.5% during the month.

In China, economic indicators were much weaker than anticipated. On the inflation front, CPI turned negative in July at -0.3% year-on-year, while the Producer Price Index (PPI) remained in deflationary territory for the tenth consecutive month. Retail sales fell well short of expectations, growing at a mere 2.5% year-on-year instead of the anticipated 4.5% year-on-year. A near-term rebound appears unlikely, given persistently low household confidence.

Chinese investment data underscored low business confidence as private investment declined by 2.3% year-on-year in July, with the real estate sector experiencing the sharpest drop, registering an 8.5% decrease in investment between January and July compared to the same period the previous year. The challenges faced by major property developers, such as Country Garden and Evergrande, further underscored the fragility of the real estate sector in August.

In an effort to address these challenges and deflationary risks, the People's Bank of China (PBoC) lowered interest rates twice in August, but credit demand remained sluggish. Towards the end of the month, Beijing implemented several initiatives to bolster financial markets, including halving the stamp duty on stock trading. Despite these measures, the Renminbi depreciated by 1.6% against the US dollar for the month, while the CSI 300 index tumbled by 6.2%.

In Japan, the economy expanded by 6.0% quarter-on-quarter in Q2 2023, driven by a robust contribution from net trade. Leading indicators like the Tankan index suggested that this strong momentum would continue in the coming months. Japan also appeared to be leaving its deflationary period behind, with core CPI increasing by 10 basis points to 4.3% year-on-year in July. Spring (Shunto) wage negotiations led to the largest wage increases in 30 years. Compared to other markets, Japanese equities exhibited relative resilience in August, with the Topix posting a modest gain of 0.41%.

As discussed in our mid-year outlook, market expectations for a "Goldilocks" scenario, which supported global markets until the end of July, may have been overly optimistic. August's volatility highlighted a growing concern among investors.

China's challenges are expected to weigh on the global economy in the coming months, given its significant contribution to global growth. Moreover, despite easing inflation pressures, risks have not entirely dissipated, and central banks are likely to maintain tight policies beyond 2023.