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Article | 06 March 2023 | Investments
Global stocks retreated over February, as hopes that central banks might soon pivot to a more dovish stance were dashed by sticky inflation data. US stocks lost 2.6% (S&P 500 Index) amid speculation some policymakers were pushing for a 50 bps increase at the next Fed meeting. Chinese stocks also fell sharply, although onshore stocks (CSI 300 Index -2.1%) proved more resilient than offshore ones (MSCI China -10.2%). In contrast, European and Japanese shares rallied modestly (EuroStoxx 50 +1.8%; TOPIX +0.9%).
Global bonds sold off on the belief that rates would need to be higher for longer to tame inflation. In the US, the 10 year Treasury bond lost 3.1% as yields retested 4.0%, a level last seen in November 2022; in Europe, the 10 year German Bund fell 2.7%, with yields touching 2.6%, the highest level since July 2011. In the credit markets, high yield held up better than investment grade bonds as their larger coupons proved relatively more attractive.
The US dollar strengthened as investors priced in further Fed rate hikes. The British pound initially weakened as the BoE indicated that rates might have peaked, but recovered later in the month on news that the UK and EU had reached agreement on improving Northern Ireland’s post-Brexit trading arrangements. The euro strengthened against the Japanese yen, reflecting the divergent monetary stances of the ECB and the Bank of Japan.
While oil prices closed the month little changed (Brent crude -0.7% at $83.90 a barrel), European natural gas prices continued to fall amid growing confidence that Europe would be able to manage without Russian gas for both this winter and next. Elsewhere, gold prices slid 5.3% to $1,826.90 a troy ounce.
Volatility rose modestly, with the Vix Index increasing 6.7% to close February at 20.7. A reading below 20 is widely viewed as an indicator of market stability.
Germany threatened to block EU plans to ban new cars with internal combustion engines from 2035, unless Brussels exempts vehicles that run on e-fuels, such as
e-methane and e-kerosene. E-fuels are produced using electricity from renewable hydrogen and other gases and so are often considered to be carbon neutral.
Tensions between the US and China rose after the US shot down a balloon, which it alleged that China was using for the purposes of espionage. The US also warned China against supplying Russia with weapons, saying it could risk escalating the war in Ukraine.
Major central banks continued to hike rates. The US Federal Reserve (Fed) implemented a 25 basis point (bps) hike, its smallest this cycle, while the European Central Bank (ECB) and Bank of England (BoE) each raised rates by 50 bps. The BoE suggested it might have reached its terminal rate, whereas both the Fed and the ECB indicated that further rate increases should be expected.
The US economy started the year in robust form, with job growth in January around three times higher than market expectations. The deceleration in US inflation appeared to be easing, with some measures indicating that underlying inflation had started to accelerate again.
Pressure on the ECB to maintain its hawkish stance will likely continue at its meeting in mid March, after early estimates showed that February’s inflation rate had accelerated for the second consecutive month in France and Spain, while German inflation levels remain stubbornly high. At the same time, BoE governor Andrew Bailey could continue to signal that UK rates are unlikely to rise from the current level of 4%.
US inflation has also proved stickier than expected. The core personal consumption expenditure (PCE) index, the Fed’s preferred measure of inflation, rose to 4.7% year-on-year in January from 4.6% in December, suggesting that underlying inflation may no longer be decelerating. With the US economy running hotter than expected, the key question is how much will the Fed raise rates at its meeting in mid-March?
Kazuo Ueda will become the next governor of the Bank of Japan in April. Market commentators will be watching closely to see whether Mr Ueda gives any indications of ending Japan’s ultra-loose monetary stance. Japanese inflation rose to a year-on-year rate of 4.3% in January, the highest level since 1981.