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Risk-Off on Higher Rates Outlook
This past week witnessed a flurry of central bank actions and statements, contributing significantly to the direction of global markets. Markets experienced some turbulence across various asset classes, largely due to the active stance adopted by six central banks in advanced economies, including the Fed. While most of these central banks maintained policy rates steady, the prevailing hawkish sentiment reverberated through regions (except for Japan), prompting a widespread sell-off.
The primary catalyst for this turmoil was the Fed's hawkish outlook, even though it opted to keep interest rates unchanged, as widely expected. Concerns loomed over the possibility of a recession if rates remain at these elevated levels for an extended period, translating into higher borrowing costs for corporations and subsequently reducing profit margins. Furthermore, the persistent elevation of crude oil prices added to the concern.
For nearly a year, investors have been eagerly anticipating the arrival of peak interest rates, a goal that continues to move further into the future. The week's stock market performance largely revolved around coming to terms with this evolving reality.
Against this backdrop, the dollar continued to strengthen, interest rates maintained their upward trajectory, and equities experienced steep declines, particularly impacting mega-cap growth stocks, which recorded significant losses.
Despite the weakness in stock valuations, two large IPOs and one big tech M&A deal, worth $28bn, were priced during the week.
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Higher Rates for Longer
It was an eventful week in monetary policy, significantly impacting global market performance.
● The Federal Reserve, as anticipated, maintained the Fed Funds target rate at 5.25-5.5%. However, the FOMC revealed a hawkish outlook, projecting prolonged high and restrictive rates to combat inflation effectively. This stance, supported by robust economic data indicating a soft landing scenario, aims to ensure inflation reaches its 2% target. Forecasts suggest elevated rates will persist into 2026.
The Fed's dot plot projections show a rate of 5.1% by the end of ‘24, accompanied by a decline in inflation to 3.3% by the close of ‘23, further dropping to 2.5% in ’24, to 2.2% by the end of ‘25 and eventually reaching the 2% goal the following year. The surprise lay in the signalling of another rate hike, expecting a mid-range peak of 5.625% and fewer rate cuts in the coming year, a clear and unexpected hawkish tone.
"People hate inflation. Hate it," emphasized Fed Chair Jerome Powell.
● The Bank of England delivered a surprise by maintaining its base rate at 5.25%, contrary to market expectations for another hike. The decision, influenced by a divided vote of four in favour of a hike against five advocating no change, followed an inflation reading revealing a significant drop in core CPI to 6.2% and a modest decrease in headline CPI to 6.7%. This marked the first meeting where the BoE refrained from rate hikes since late 2021.
Futures markets now estimate a 50% chance of a 25bp hike by year-end. Governor Bailey emphasized that the bank's mission was not yet complete.
"There are increasing signs of some impact of tighter monetary policy on the labour market and momentum in the real economy more generally," stated the BoE.
● The Bank of Japan adhered to expectations by keeping its ultra-low interest rate steady at -0.10%. It maintained a dovish guidance, signalling no immediate plans to withdraw its substantial monetary stimulus. The bank retained its 10-year JGB yield goal at 0% and its inflation target at 2%.
● The Swiss National Bank surprised analysts by leaving rates unchanged at 1.75%, the first time since March 2022. However, they did not dismiss the possibility of further tightening measures in a hawkish message.
"There is still existing inflationary pressure, and we do not know for certain if this inflationary pressure will increase again," remarked the SNB Governor.
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● Both Sweden and Norway's central banks increased their benchmark rates by 25bp to 4% and 4.25%, respectively, aligning with expectations. Norway’s Norges Bank indicated another rate hike in December, projecting a 4.5% rate throughout 2024. Norway grapples with a core CPI inflation rate of 6.3%. Meanwhile, Sweden's Riksbank, perceiving inflation as still too high with headline CPI at 4.7%, signalled further rate hikes.
"Developments are moving in the right direction, but inflationary pressures in the Swedish economy remain too high," asserted Riksbank.
● Joaquim Nagel, President of Germany's Bundesbank, cautioned that €zone inflation remains high, with the risk of becoming entrenched if businesses anticipate rising inflation and adjust wages accordingly. The block’s headline inflation declined marginally to 5.2% in August, only slightly lower than in July.
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Interest Rates
Last week's currency markets witnessed a surge in the DXY dollar index, marking its tenth consecutive weekly gain, reaching a 10-month high at 105.6 points. This ascent was spurred by the resilience of the US economy throughout the year, defying predictions of a recession. Meanwhile, the £ experienced a significant setback, declining by 1.2%. The Bank of England's unexpected decision to maintain its base rate, contrary to analyst expectations of a hike, triggered this downward move.
In the realm of interest rates, another noteworthy development unfolded as the Federal Reserve chose to keep rates within the 5.25% to 5.5% range, emphasizing, with a clear hawkish tone, their commitment to sustaining these levels for the necessary duration to curb inflation and return it to the coveted 2% mark. Simultaneously, interest rates continued their upward trajectory.
US Treasury yields surged to a 16-year pinnacle. The short end of the yield curve, most sensitive to central bank policies, experienced a slight increase. The 3-month Bill concluded at 5.48%, while the 2-year Note closed at 5.12%. The 10-year Bond reached 4.44%, the highest since 2007. Except for UK Gilts yields, which fell, all other developed markets observed an increase in yields during the week.
Commodities 
● Crude oil prices experienced a slight decline of ~1% during the week. This dip was primarily attributed to profit-taking following a significant rally in the preceding weeks. Concerns over oil supply emerged as Russia implemented a temporary ban on gasoline and diesel exports. Early in the week, crude oil prices surged above $95 per barrel, marking their highest point for the year. Notably, Saudi Arabia and Russia, key players in the global oil market, extended their voluntary output cuts despite the rising prices.
Russia's decision to temporarily ban gasoline and diesel exports, with exceptions for four ex-Soviet states, aimed to address domestic fuel shortages and curb price increases. However, this move could potentially lead to oversupply challenges and logistical bottlenecks.
The export ban, initiated on Thursday for an unspecified duration, primarily impacts gasoline and ultra-low sulfur diesel, excluding heating oil. The Russian domestic market immediately reacted with gasoline prices dropping by 10% and diesel prices down by 7.5% on Friday.
● Wheat and soybean prices faced a decline of nearly 4% over the week. This drop was largely influenced by the strengthening dollar but also to updates in Black Sea ports. Wheat prices, in particular, approached a three-year low at $5.8 per bushel. An important development in the departure of the first major grain shipment from a Ukrainian Black Sea port since Russia withdrew from an export deal in July. Russia's Black Sea ports are crucial for global grain supply, handling ~70% of the country's wheat exports.
Broad Sell-Off
The stock market experienced significant weakness, primarily attributed to the Fed’s hawkish stance and its announcement of forthcoming interest rate hikes. The impact of this news was felt more strongly in growth stocks than in value stocks, resulting in a sharp decline in several mega-cap companies.
• The S&P 500 and Nasdaq Composite indices reported their weakest performance in the last six months and are currently trading at levels not seen in the past three months.
• The consumer discretionary sector, which includes companies like Tesla (-11% WTD) and Amazon (-8%), experienced its most significant decline in a year, plummeting by 6%. Real estate stocks were similarly affected as higher interest rates erode their profit margins and increase borrowing costs.
• Canada's TSX Composite index suffered the most significant drop among developed benchmarks, losing 4%, marking its worst week in a year. Shopify (online retail, mcap $68bn), a major component of the index, declined by 16%.
• Regarding earnings reports, FedEx Corp (mcap $66bn) saw a notable boost after reporting impressive profit figures (+32% YoY), ending the week 2.7% higher.
• Tesla's car sales in China fell below expectations, registering a roughly 30% decline in September compared to the average in the previous quarter. This challenges Tesla's ability to achieve the consensus estimate of 473,000 unit sales for Q3. Investors are now looking forward to a delivery update from Tesla in early October, just ahead of its earnings report scheduled for the 17th.
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