08/18/2023

Over the past few weeks, global financial markets have been hit by a summer storm. There are two underlying factors for the weakness in fixed income and equities in August: First, macroeconomic data released in the United States (retail sales, employment, industrial production, and the housing market) have led investors to believe that the Fed's cumulative rate hikes have done little to slow U.S. economic activity for the time being, and that further monetary tightening may be needed to bring inflation toward its long-term goals.

Consequently, there has been an overall upward trend in government bond yields, surpassing previous records and currently standing at levels not observed in 15 years. Several contributing factors have influenced this phenomenon, including the potential credit rating downgrade of US debt by rating agency Fitch, an unexpected uptick in UK inflation, and underwhelming demand during a Japanese Treasury bond auction. Of course, the rise in interest rates has directly penalized bond markets, but it has also had a negative impact on global equity markets, especially on some very interest rate-sensitive sectors such as technology.

Second, the deterioration of economic data in China and renewed concerns surrounding the real estate market in the Asian powerhouse have compounded the stress on investors who were previously benefiting from two months of robust stock market gains. Ironically, the negative implications of feeble macroeconomic indicators in China predominantly affect European stock markets, while positive economic data in the United States is also viewed unfavorably, due to the belief that optimistic US data raises the probability of additional interest rate hikes by the Federal Reserve.

Apart from these two fundamental factors, there are various technical elements that have played a role in shaping the current situation. These include the historically low liquidity typically associated with August, as we previously highlighted in our podcast a few weeks ago. Additionally, the seasonality during this time of the year is generally unfavorable for equity markets, and the substantial technical overbought conditions that were accumulated in the preceding months of June and July. In short, all these elements have come together to create a familiar scenario of a summer storm in the financial markets, a phenomenon frequently observed during the month of August.

At this point, it is necessary to analyze the latest events in order to find out whether we are facing a new opportunity to buy or, on the contrary, in the prelude to the most significant setbacks in the coming months. On a positive note, it is evident that the complacency we observed a few weeks ago has completely evaporated, and investors now appear to be more accurately assessing the current risk environment.

While we await the crucial annual meeting of central bankers at Jackson Hole, which will give us a full understanding of the message from the world's monetary authorities, one thing remains obvious - the disinflation trend, albeit gradual, uneven and inconsistent, continues in the developed world. Central banks are well aware that the effects of monetary policy have a lagged impact on real economic activity. Moreover, as a key benchmark, the Federal Reserve has a dual mandate that requires maintaining stable economic activity and employment levels.

Therefore, despite the recent strength in economic indicators, we do not anticipate a significant change in the Federal Reserve's monetary policy stance. As a result, it is likely that Powell's message will continue to emphasize a commitment to fighting inflation while recognizing the progress made to date in bringing prices into line with their long-term objectives.

Furthermore, the level of uncertainty surrounding economic activity in China is potentially reaching unprecedented heights, primarily due to the absence of definitive policy actions following the Politburo meeting. Currently, pessimism appears to be at an extreme level, but without a distinct catalyst such as a substantial fiscal stimulus, it is improbable for sentiment towards China to undergo a sustainable reversal on its own. Nonetheless, policymakers are exhibiting growing concerns, as evident in their efforts to uphold the value of the yuan. This suggests that more ambitious measures may be announced in the upcoming weeks.

To sum up, the immediate future of the market is uncertain, but our overall outlook for the entire year remains the same. It is important to note that the developed economies' ability to withstand challenges has resulted in the predicted recession for 2023 being postponed. So, it seems highly improbable that there will be a global economic recession towards the end of this year, and this should help keep stock prices stable. In light of this, we maintain our confidence in a soft landing scenario, which would continue to attract investors to higher-risk assets and contribute to a gradual return to normal in bond yields.