The Reserve Bank of Australia lifted the cash rate by another 50 basis points in early September to 2.35%, as many economists had predicted. However, after remaining relatively steady for a while, yields surged higher following hawkish Fed signalling and dislocation in the UK Gilts market following the release of a widely criticised mini-budget. AU3Y government bond yields reached a high of 3.72% before closing the month 32 basis points higher at 3.52%. Meanwhile, AU10Y and AU30Y yields closed the month up 29bps and 26bps, respectively, at 3.89% and 4.08%.
Hawkish forward guidance from the US Federal Reserve and a surprising UK fiscal package meant the Bank of England had to step into the Gilts market. With policy tightening ratcheting up, increasing the chance of recession, risk appetite soured. Equity markets fell while credit spreads widened. Consequently, the Australian bond market gave back -1.35% in September (Bloomberg AusBond Composite 0+ Yr Index).
The Australian economy advanced by +0.9% over the June quarter, driven almost entirely by consumption and the external sector. Despite extremely soft consumer confidence, increased cost of living worries, and tighter economic policies, momentum appears to be continuing into the third quarter. According to the NAB Business Survey, company conditions, labour demand and capacity usage remained well above long-term averages throughout July and August. In August, employment increased by 33,500 people, with the unemployment rate climbing to 3.5% as labour force participation rose.
The Australian interest rate futures market anticipates more tightening from the RBA in the months to come. The 90-day bank bill yield rose 61bps to 3.06%, while the 180-day bank bills increased 56bps to 3.57%, implying where the cash rate will be in 90 and 180 days. The cash rate pricing by the end of 2022 sits at 3.32% and 4.10% by mid-2023.
- Global equity benchmarks are on track for the worst annual performance on record
- The US10Y yield had its biggest monthly gain in September
- Currency wars are driving record swings in global FX markets
- The US Fed has hiked 3% since March, with another 1.25% expected by December 2022
- Economic data continues to reflect slowing growth and high price increases
In September, the major US equity indices lost between -8% and -11%, which is typically the weakest month of the year for US equity performance. The Dow Jones Industrials (-8.8%), which is known for its growth, was the outperformer, while the Nasdaq 100 (-10.5%), which favours development, lagged behind. The S&P 500 (-9.2%) ended at its lowest level since November 2020. By the end of September, all three large-cap benchmarks had fallen below their 52-week lows set in June, meaning there was an increased risk for more decline. This trend was also confirmed by the Dow Jones Transportation Index making new lows.
Growth/Value
Both large-cap and small-cap Growth stocks outperformed Value stocks in September; however, on a YTD basis, Value is still the relative outperformer. The sharp rise in rates has had a greater negative impact on longer-duration growth stocks whose earnings power is further into the future.
US Dollar
The US Dollar Index (DXY) climbed to 17.2% so far in 2022, which is the biggest annual increase since 1967, when the index was first created. The highest annual gain previously was 15.8% in 1981. Emerging market currencies in particular, are struggling to compete against the historical strength of the US dollar. The Japanese Yen has seen a record -25.8% decline, while the Euro and British Pound have declined by -13.4% and -17.5%, respectively. The sharp rise in the value of the global reserve currency increases debt servicing costs and trade for foreigners, which acts as a significant headwind for global economic activity.
Fixed Income
The US Aggregate Bond Index is down 14.6% so far this year. Since 1976, it has never fallen more than 3%. The Global Aggregate Bond Index has lost 19.9% of its value versus a previous record decline of 5.2% in 1999. There are growing concerns that the steep drop in bond prices might create a "break" in the worldwide financial system, requiring a central bank to pivot as a result. The Bank of England's recent intervention in long-dated Gilts could be seen as the first pivot of some kind of permanent yield curve control from the Central Bank.
Energy Markets
WTI crude tumbled 11.2% in September, its most significant monthly decline in 2022 and the fourth consecutive month in the red. While inventories remain tight, demand is declining owing to a global recession. Copper (-3%) fell for the sixth month in a row. Gold slid by -3%, while silver advanced by +5.8%.
US Macro
The unemployment rate in the US is still very low, with only 3.7% of people unemployed. This number is near an all-time low for this generation. The ratio of job openings to unemployed people is also at a record high, 2-1. Although average hourly earnings have been rising every month, real wages have decreased by about 4% since June. This could be part of the reason why consumer sentiment has recently hit a record low.
The Months Ahead
The recent worldwide central bank intervention in FX and treasury markets was a direct response to global headwinds such as the sharply rising inflation rates and strengthening US Dollar. The Federal Reserve has barely begun its increased level of quantitative tightening, and its balance sheet is close to $9 trillion. Markets expect another 125 basis points in rate hikes over the last two FOMC meetings in 2022, even though we are still yet to feel the economic impacts of prior hikes. In the meantime, we can't forget about geopolitical risks- for example, look at what happened with the Nord Stream gas pipelines.