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Markets last week
Summary
Equity markets ended the week flat, with four-out-of-five trading days being positive
Markets stabilised over the week following the recent bout of volatility; despite a broad-based equity sell-off on Monday
Key factors behind the unrest included the unwind of the Japanese Yen carry trade* and recession fears in the US, both of which have eased
Economic activity is slowing, but from a high starting point, and inflationary pressures are subsiding, making the environment seemingly constructive for equity markets
The unwind of the yen carry trade was driven by changing monetary policy in Japan. Japanese equity markets fell 12% on Monday before recovering to end the week -2.1% lower
Investors are repositioning their portfolios in response to new monetary policy phases in Japan and the western world
Defensive sectors like health care and utilities lost some of their recent gains, while cyclicals, particularly industrials, energy, and financials, outperformed. Consumer-related stocks remained under pressure
While equity markets are leaning towards a ‘soft-landing’ scenario, the bond market is pricing in a recession, with potentially excessive interest rate cuts expected by the end of the year
Bonds returned to their role as a volatility dampener, performing well during the equity market decline, but giving back some gains as fears subsided
The US ten-year yield rose by 0.15%, and the UK ten-year yield rose by 0.12%
Upcoming US inflation data could unsettle markets, especially if core inflation does not soften as expected. The US Federal Reserve (Fed) is likely to cut rates at its next meeting in September.
*Borrowing or selling a low-yielding currency to fund the purchase of a higher-yielding currency.
Markets last week
Market environment
Markets stabilised over the week following the recent bout of volatility, which culminated in a broad-based equity sell-off on Monday. There were two key factors behind the market unrest: the unwind of the yen carry trade and fears of a recession in the US. Last week both fears were tempered and although four-out-of-five trading days were positive, equity markets ended the week flat.
Recession fears tempered
Short-term volatility can distract from the business of investing and recently, markets have been reacting to noise inherent in economic data. The outsized equity market move on Monday was driven in part by the weak payrolls data on the previous Friday. With some time to digest recent events, traders were able reflect on the macro environment and realise that although economic data in recent months has been soft there’s insufficient evidence so far to suggest that a hard landing is imminent. In support of the positive reading the ISM Services index data last week was stronger than expected, and on Thursday initial jobless claims were encouraging. This led to a bounce in equities. In fact, the US equity market reported its best day since 2022 on Thursday. The weeklyjobless claims data is volatile and the reaction points to how markets remain sensitive to noisy economic data, creating short-term volatility.
Although economic activity is slowing, it’s doing so from a high starting point and inflationary pressures are subsiding. With the first interest rate cut in the US forthcoming, the backdrop for equity markets seems constructive for the time being. The market stabilisation over the week was in recognition of this fact. There’s uncertainty ahead and volatility surrounding noise in the data is likely to persist as we head into an unusual easing cycle.
Yen carry trade
The unwind of the Yen carry trade is more structural; the changing monetary policy environment presents a pivotal moment for Japanese markets. After the Bank of Japan (BoJ) hiked rates for the second time in 17 years, and the second time this year, Japanese equity markets descended into a free fall culminating with a 12.4% decline on Monday. The BoJ, on seeing the consequences of their hawkish rhetoric, stepped in to assure investors that it will not throw caution to the wind and risk more market turmoil with further aggressive tightening. The Japanese equity market quickly recovered over the remainder of the week to close -2.1% lower.
Investors have recognised that monetary policy in Japan and the western world has now entered a new phase and took the opportunity to reposition portfolios away from crowded trades.
Equity markets
Defensive sectors like health care and utilities gave back some of their recent outperformance, while cyclicals, particularly industrials, energy, and financials, were the best performing. Consumer-related stocks remained under pressure. After a poor week last week, European equities performed well, US equities were flat, and UK equities were mildly negative.
While fears of a hard landing have subsided for now, the market remains sensitive to economic indicators and policy decisions. Any surprises in the US inflation print this week could stoke further reaction.
Bond markets
Whereas equity markets were recently pricing in ‘no chance’ of a landing, and are now closer to a soft-landing scenario, the bond market is clearly pricing in a recession. The interest-rate cuts priced into the market seem excessive. Fed funds futures are pricing in four 0.25% cuts for the remainder of the year with only three Federal Open Market Committee meetings to do so. This implies a sharp easing cycle, which would realistically only take place in the event of a more severe economic downturn. The Fed’s expectations based on their quarterly forecasts (most recently updated in June), is for one 0.25% cut this year.
The good news for multi-asset investors is that the bond market has gone back to being the volatility dampener that traditional portfolio theorists rely on. The week before last, when equity markets were falling, bonds performed excellently. Last week when the underlying fears subsided the bond marketgave back some of those gains. The US ten-year yield rose 0.15% while the UK ten-year rose 0.12% last week.
The week ahead
Wednesday: US inflation
Our thoughts: On an annual basis, headline inflation in July is expected to remain at 3% while, importantly, core inflation, which excludes the volatile food and energy components, is expected to soften marginally from 3.3% to 3.2%. The Consumer Prices Index data could unsettle markets a little considering the current nervousness, particularly if core inflation does not soften as anticipated. The Fed is likely to cut rates at their next meeting in September in the absence of any major surprises.
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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity. Where investment is made in currencies other than the investor’s base currency, the value of those investments, and any income from them, will be affected by movements in exchange rates. This effect may be unfavourable as well as favourable. Past performance and future forecasts figures are not a reliable indicator of future results.
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