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Global bond yields continued to surge higher in September, led by the US, as markets started to price in the likelihood of a 'higher for longer' interest rate policy. This led to a sharp increase in the difference between short and long-term rates or a steepening of the curve as central banks extend their policy cycles. On the back of this sell-off, the Australian bond market, as indicated by the Bloomberg AusBond Composite 0+ Yr Index, experienced a decline of -1.53%. 

Volatility in the bond market continued until late in the month, as the gains from August were quickly eroded as the market pushed to new year-to-date lows. During their September meeting, the Reserve Bank of Australia maintained their cautious stance by keeping the interest rate at 4.10%. By the end of the month, the yield on the AU3Y government bond increased by 34 basis points to 4.08%, while the AU10Y yields rose by 46 basis points to 4.49%. 

The realisation that rates will have to stay elevated for an extended period is starting to establish itself with expectations of marginally more tightening by central banks but a prolonged economic cycle. Futures markets are currently anticipating only one more interest rate hike from the RBA by April 2024, with no plans for rate cuts that year, with similar expectations in US markets. Long-term yields have surged, with some now trading above pre-2008 financial crisis levels. The Australian yield curve has steepened, and the US curve has become less inverted in recent weeks. 

Uncertainties remain in the global economy. The recent increase in oil prices has stoked debate about the possibility of inflation returning. Specifically, Australia's monthly CPI data was primarily influenced by a rise in fuel prices. With inflation at an annualised rate of 5.2% and the core measures showing moderation, the RBA will observe the situation rather than take immediate action. The labour market is starting to cool off, but it is worth noting that it started from a high level, indicating only modest wage growth. Leading indicators such as the underemployment rate, job vacancies, and job advertisements are pulling back from recent highs and starting to moderate. The unemployment rate in Australia is currently at 3.7% and remains within the range of full employment. 

Economic growth in Australia is inconsistent with the second quarter GDP meeting expectations, with a YoY increase of 2.1%. However, household spending was moderate, and inventories were significantly decreased. Public investment helped offset this, but overall, the growth rate for the quarter was below average at 0.4% vs the previous quarter. Net exports have been a positive factor, but they are slowing down, and imports are declining even faster. This trend is expected to continue due to the decrease in the value of the Australian dollar. Despite some temporary entertainment-related spending, the consumer sector remains weak. Momentum is slowing down, and the decline in aggregate savings results from past consumption. Real disposable income is also decreasing, indicating that this trend will likely continue. 

Global markets were pessimistic during the month as investors returned from their summer break and were faced with an unclear macro outlook, which is typical for this time of year. Investor confidence was also affected by a significant increase in yields and mounting evidence of a slowing global economy. Market participants reconsidered the likelihood of a smooth economic transition as they contemplated a wider range of possible outcomes. One potential scenario gaining credibility is weaker economic growth coupled with a prolonged period of high interest rates to counter persistent inflation (stagflation), which could negatively affect various risky investments. 

September Market Summary

• US stock markets posted negative quarterly performance for the first time since the third quarter of 2022
• The US Dollar posted 11 consecutive weeks of gains for its second-longest up-trend in the past 50 years
• Oil markets advanced higher, with WTI Crude up by +29% in Q3
• Long-term US Treasury yields rallied, trading up to 2009 levels 
• Futures markets are only pricing a 30% chance of one more rate hike from the US Fed this year

US Equity Markets

August and September have gained a reputation in equity markets for poor performance on a seasonality basis due to consistently negative monthly returns on average dating back to 1970. Out of all the months, only September has had a negative average monthly return during this 50+ year period. The major US equity benchmarks lived up to this reputation by experiencing declines in August and September, marking the first time since Q3 2022 that they had a quarter with negative returns. The Dow Jones performed relatively well compared to other benchmarks in both September and Q3, while the smaller cap Russell Microcap and Russell 2000 indices performed the worst in these periods. 

Mega-Cap Performance

At their July highs, the Nasdaq-100 and S&P 500 came within 5% from the prior all-time highs set in late 2021 / early 2022. After the recent weakness ending Q3, the Nasdaq-100 stands at +41% from its 52-week lows. Conversely, in the last week of September, the Russell Microcap Index broke a 15-month support level to a new cyclical low while the Russell 2000 resided in the lower third of its prior 15-month trading range.

The strong year-to-date gains in the large-cap benchmarks are influenced mainly by a select group of mega-cap stocks. These companies, referred to as the 'Magnificent Seven', have significant representation in the Nasdaq 100 and S&P 500 indices, accounting for 43% and 27% respectively. Moreover, the Bloomberg Magnificent Seven Total Return Index has seen an impressive +84% performance year-to-date.

Sector Disparity

The sector level also shows a tale of disparity, with five out of eleven sectors experiencing losses year-to-date. Communications and Technology have seen positive gains of 40.4% and 34.7%, respectively, while the defensive sectors of Utilities and Consumer Staples have seen declines of 14.4% and 4.8%. In a market where 12-month Treasury bills are yielding over 5%, the higher-yielding defensive sectors are not as enticing compared to the Zero Interest Rate Policy or ZIRP era. September saw declines in ten out of eleven S&P 500 sectors, and nine out of eleven sectors were down for the entire third quarter. Energy and Communications performed well during the quarter, while Utilities, REITs, and Healthcare were the weakest performers. 

US Treasuries

Volatility continued in the US Treasury market, with the US30Y yield surging higher by 84 basis points in Q3, making it the largest quarterly gain in over 14 years. This surge also brought it to its highest level since 2011. The US10Y yield also saw a gain of 74bps in Q3, reaching a peak of 4.69%, which is the highest it has been in the past 16 years. As the Federal Reserve nears the end of its rate hike cycle, the shorter-term US2Y yield only rose by a modest 15bps. There has also been a 'bear steepener' trend throughout the third quarter. After hitting a low of -108bps in both March and June, the spread between the US10Y and US2Y UST has gradually increased. In the last seven sessions of the month following the September 20th FOMC meeting, the spread steepened by an additional 30bps, closing the quarter at -47bps. 

Oil Markets

Energy prices have surged due to the supply cuts implemented by OPEC+ and Russia. WTI crude oil rose by 29% in Q3, and up to 40%, from the last week of June to the peak in late September. The rise in energy prices hurts consumers and businesses, hindering future economic activity and reducing the chances of a smooth economic transition. Both petrol and heating oil prices saw significant increases of 41% and 37%, respectively, while natural gas prices in the EU rose by 13%. Precious metals such as gold and silver saw declines of 4% and 2%, respectively. The performance of industrial metals varied during the third quarter, with aluminium increasing by 7% and palladium increasing by 3%. However, nickel (-8%), steel (-3%), and copper (-0.1%) all experienced decreases.

The US Dollar

The US Dollar Index (DXY) ended Q3 by achieving eleven straight weeks of gains, the second longest streak in over 50 years and trading to fresh all-time highs in 2023. Despite the impressive run higher, it is important to monitor the greenback's performance due to its strong negative correlation with the S&P 500. The DXY experienced a relatively modest increase of 3.2% for Q3, with the dollar appreciating against nine out of ten G10 currencies and most emerging market currencies.

Fixed income yields have experienced wide ranges in the past month, trading up to their cyclical highs before consolidating into month end. The state of the Australian economy remains uncertain, which has been reflected in the bond market. During their August meeting, the Reserve Bank of Australia also shared this uncertainty and decided to maintain a cautious stance, keeping the interest rate steady at 4.10%. By the end of the month, the yield on the AU3Y government bond had decreased by 13 bps to 3.74%, while the yield on the AU10Y government bond decreased by 3 bps to 4.03%. As the Bloomberg AusBond Composite 0+ Yr Index indicated, the Australian bond market saw a positive +0.74% increase for the month.

Early in August, there was much talk about the US economy not slowing despite the best efforts from the Federal Reserve to cool things down. This caused yields to increase as the market started to price more rate hikes from the Fed. The potential for more US bond issuance because the outlook for the fiscal deficit was getting worse. Global inflation is trending lower, but not as fast as some would like, even as many supply chain pressures abate. This has caused speculation that central banks will have to keep rates higher for longer to bring down inflation.

The RBA is considering the inflation risks compared to the weakening household sector. The CPI reading for the month came in lower than anticipated, at an annualised rate of 4.9% in the July reading, which is a slight improvement from the 5.2% YoY reading seen in June. However, the core inflation remained steady, with rent and energy costs increasing significantly. Wages showed stability, rising 3.6% compared to the previous year, although larger gains are expected in Q3 after the rise in award wages. Unfortunately, the household sector is not doing well, with real retail sales declining by -0.5% in Q2 compared to the previous quarter. Nominal monthly retail sales increased, driven by the World Cup and seasonal factors, but indicators suggest further weakness in the future. 

The cash rate futures markets are taking into account the uncertainties and only factoring in a slight increase in the cash rate from the RBA, reaching a peak of 4.16% in early March 2024. An interest rate decrease is not expected until late 2024. Compared to the current cash rate of 4.10%, the yield on the 90-day bank bills decreased by -13bps to 4.13%. Similarly, the rates for 180-day bills fell by -27bps to 4.37%. 

US Equity Markets

US stock indices ended the month of August lower, marking the first time that both the S&P 500 and NASDAQ-100 have seen a monthly decline since February. The top seven stocks, which accounted for more than 75% of the NASDAQ gains from January to July 2023, had mixed results in August. Despite the significant slant towards growth stocks, the index, which has a strong presence in the technology and AI exposure, fell by -1.5% for the month but is still up by more than +42% year-to-date. 

US Downgrade

Fitch Ratings lowered the United States' credit rating by one notch (from AAA to AA+). This was due to an increase in debt at the federal, state, and local levels and a "consistent decline in governance standards" over the last twenty years. The decrease in ratings, coupled with significant government bond issuance, actions taken by the Bank of Japan, and a shift in perspective regarding interest rates remaining elevated for an extended period, resulted in US treasury yields rising from levels below 4% to reaching as high as 4.35%, before eventually settling at 4.11% by the end of August. The instability in the bond market prompted a decline in equity market prices for the first three weeks of the month but consolidated in the last week of trade. 

The market was also influenced negatively by worries about China's property sector. Other relevant indicators, such as credit, economic growth, and deflation, demonstrated poor performance. Unexpected adjustments were made to equity market trading rules, there was a decline in consumer confidence, mortgage rates were cut, access to youth unemployment data was restricted, and several major real estate developers filed for bankruptcy. 

US Treasury Market

There was a major sell-off in the US bond market in August, leading to the US10Y yields trading to their highest level in 16 years. Currently, the yield on the US10Y treasury trades at 4.25%, lower than the high of 4.35% seen earlier in the month. The yield on the US30Y treasury sits at 4.36%. The shorter-term US2Y yield remained relatively stable at 4.85% throughout the month. Additionally, the yield curve has been inverted for more than a year. 

US Economic Data

The US Department of Labor's Employment Situation Report for July, released on August 4th, displayed a job creation number slightly below expectations. This marks the second consecutive month with less than 200,000 new jobs (+187,000 compared to the consensus of +200,000). The report presented a lower headline unemployment rate (3.5% compared to the consensus of 3.6%) and stronger growth in hourly wages than anticipated (0.4% compared to 0.3%). These factors indicate a strong labour market and nearly full employment. As a result, the report needed to provide more strength for the Federal Reserve to raise the cash rate, and it needed to exhibit more weakness to prompt rate cuts in the near future. The rate of people participating in the workforce remained constant at 62.6%. 

US Dollar

The USD lifted by over +1.7% in August, but it is still down by almost 8% compared to its highest point in September last year. The Federal Reserve's tightening measures supported the Dollar's strengthening last year, attracting foreign investors due to higher interest rates. However, a strong Dollar tends to hinder the performance of stocks and other high-risk investments, as more than a third of the revenue generated by S&P 500 companies comes from outside the United States. As the expectation grows that the Federal Reserve will soon stop raising interest rates, speculators are betting that the Dollar could lose further momentum in the future. 

The Months Ahead

Historically, September has been one of the worst-performing months for equity markets. According to data from the past five decades, the S&P 500 has typically experienced an average decrease of -1.08% during September. The Federal Open Market Committee (FOMC) will announce their interest rate decision on September 20th. Additionally, on September 15th, we will witness the expiration of "triple witch" options and the simultaneous rebalancing of the S&P Index.

As central banks approach peak interest rates, there is growing optimism in the markets that inflation is under control and will not negatively impact economic growth. This has led to some divergence in bond yields across the curve. Shorter-term rates anticipate a peak in policy in the near future, while monetary policy remains stable for a more extended period in longer-term yields, thus reducing long-term risks. The Australian bond market, as represented by the Bloomberg AusBond Composite 0+ Yr Index, experienced a 0.5% gain for the month of July. 

The Reserve Bank of Australia (RBA) decided to halt its increase in interest rates, keeping the cash rate steady at 4.10% during the meeting in July. The RBA continues to assess the data and is evaluating the risks from both sides, taking into account the already significant increase in interest rates and the impact on households. AU3Y government bond yields decreased by 18 basis points (bps) to reach 3.87% by the end of the month, while AU10Y government bond yields rose by 4bps to reach 4.06%. 

The economic data in Australia presents a conflicting picture, which the RBA has to navigate carefully. During the meeting, they emphasised the peak in inflation as a reason for pausing. The primary measurement of inflation, called the Consumer Price Index (CPI), is showing a faster decline than anticipated, which is positive news. This trend has been observed globally. However, the persistent increase in inflation within the services sector, which occurred in the second quarter, reinforces concerns about low productivity growth and high wage growth. In the second quarter, the CPI decreased to 6% compared to the previous year-on-year reading of 7%, indicating a positive direction, while the trimmed mean CPI was at 5.9% year-on-year. However, the services CPI rose to 6.3% year-on-year, reaching its highest level since 2001. 

The job market in Australia remains highly competitive, with another month of increases in new jobs and a decrease in the unemployment rate to 3.5%. The jobs market is an indicator that takes time to reflect changes, and while it is currently strong, indicators for the future suggest that it may have reached its highest point. The number of job advertisements and the NAB business survey employment intentions series are lower. It is expected that wages will continue to grow at a fast pace. The RBA is concerned that high wage growth could lead to inflation if productivity remains below average. This is a significant risk for inflation. 

There were also movements at the RBA during the month. Governor Lowe's tenure will come to an end in September, with Deputy Governor Bullock taking charge as Governor in October. This ensures that policy remains consistent at the RBA. Dr Lowe revealed some operational modifications that will take effect in 2024 as a result of the evaluation. These changes include reducing the number of meetings to 8 per year and increasing the number of press conferences, among other adjustments. These changes do not have any immediate policy consequences and eliminate a factor of uncertainty. 

With the US Federal Reserve and other prominent central banks approaching peak interest rates and the RBA taking a break, the markets have extended their projections for the RBA cycle. They now anticipate a peak rate just below 4.35%, but only in the first quarter of 2024. Currently, there is only one expected rate cut in 2024. Compared to the current cash rate of 4.10%, the yields on the 90-day bank bills finished nine basis points lower at 4.26%. The yields on six-month bank bills concluded 6 basis points lower at 4.64%.

During the month, there was a shift in market sentiment to the upside. Investors were bullish due to a combination of factors such as the enthusiasm for US tech companies driven by Artificial Intelligence (AI), reasonable corporate earnings in the Northern Hemisphere, lower inflation rates, and the belief that Central Banks can successfully manage the economy without causing a sharp downturn. While there was significant activity in primary markets in the US and Europe, the domestic market in Australia was not very active as companies entered a period of silence before the release of their full-year earnings. 

The RBA is currently monitoring the relationship between the decelerating household sector, the robust labour market, and the significant increase in wages. It is known that the labour market tends to lag behind the overall economy, reflecting the monetary policy conditions observed almost a year in advance, although determining the precise turning point is challenging. While potentially in the midst of the economic peak, current policy will persist in constraining and reducing economic growth, and there is a possibility of a mild recession starting early next year. 

The market is pricing only one more increase in interest rates, but not until 2024, with the intention to maintain this policy for an extended period. However, this expectation does not fully consider the potential challenges faced by the economy in 2024. The Australian yield curve could be undervalued to a certain extent.

July Market Summary:

• The Dow Jones rises for 13 days straight, one day from the record set in '87
• S&P500, Nasdaq gain for the fifth consecutive month
• US Fed hiked interest rates 25bps, close to the end of the cycle
• Small cap stocks outpace large caps, reversing the recent month's trend
• Q2 Corporate earnings register a decline of -7.2%, the worst since early 2020
• Crude futures lift on higher demand and supply issues

US Macro

The US Federal Reserve increased interest rates by 25 basis points, bringing the target rate to a range of 5.25-5.50%. This was widely expected by the market. Although there were no significant surprises from the meeting, the market is now wondering if this is the highest rate the board will go or if there will be additional increases before the end of the year. During the press conference that followed the meeting, Chairman Powell acknowledged that the Fed's goal of 2% inflation still had a long way to go. However, he also hinted that rates could potentially remain unchanged at the next meeting in September. He stated, "If the data supports it, it is certainly possible that we may raise rates again in September." Despite these comments, the market currently reflects less than a 50% chance of another 25 basis point rate increase this year. 

In July, the first half of the US corporate earnings reports for Q2 of 2023 were released. At the middle point of the reporting season, S&P 500 companies announced a combined decrease in earnings of -7.3%, which is the biggest decline since the second quarter of 2020. There are more companies reporting better-than-expected earnings per share (EPS) results compared to recent trends, but the extent of these positive surprises is lower than the recent average. 

In terms of overall US equity market performance, every sector saw an increase during the month. Energy stocks had the highest increase of 7.4%, followed by Communications with a 6.9% increase, and Financials with a 4.8% increase. The Healthcare sector had the lowest increase at only 1.0%. 

The Months Ahead

In August, the earnings season for Q2 2023 will continue, along with a significant amount of economic data, such as the Consumer Price Index reports and unemployment data, on the 10th of August. Even though the Federal Reserve will not have its next meeting until September, the data from August will significantly influence any changes it may make to its policies. Historically, the month of August has shown an average return of -0.27% over the past 50 years. Out of those years, 26 have resulted in positive returns, while 24 have resulted in negative returns. The only month with worse returns during this time period is September, with an average return of -1.08%.

Underlying inflation is causing global uncertainty for central banks and has become the markets' primary concern in June. Many central banks have reevaluated potential risks and have decided to increase policy rates. In response, the market has pushed yields higher and delayed any plans for easing. Short- and long-term AU government bond yields rallied aggressively in June after a relatively quiet prior month.

The Reserve Bank of Australia is carefully navigating the situation as they consider the potential risks of inflation in comparison to the economic implications of tightening monetary policy. RBA's Governor Lowe expressed concern about the inflationary impact caused by the Fair Work Commission's award wage result being higher than expected and increased inflation expectations in specific sectors. Core inflation has remained persistent globally, driven by services inflation resulting from wage growth, which has elevated the risk of longer-lasting inflation worldwide, and the RBA is not exempt from this concern. 

The labour market in Australia showed strength as the unemployment rate stood at 3.6%. The economy benefited from population growth, leading to increased income. This contributed to inflation, as evidenced by the monthly CPI rising by 5.6% compared to the previous year. Services inflation remained stubbornly high. 

Following the RBA’s meeting in early June, the financial markets were taken aback by the unexpectedly bullish stance. As a result, short-term money markets adjusted their expectations and began pricing in the likelihood of two additional interest rate hikes, amounting to a cash rate of approximately 4.60%. Compared to the current cash rate of 4.10%, 90-day bank bills experienced a significant increase of 37bps, reaching 4.35%. Similarly, the yields of 180-day bank bills rose by 53bps, reaching 4.70%. 

June 2023 Summary

• The NASDAQ saw its best half-yearly performance on record
• A rotation into cyclical stocks saw a narrow market breadth improve in June
• US Home builders and industrials broke to fresh all-time highs in June
• Interest rate volatility pulled back to normal levels
• US Markets are now pricing another two 25bps hikes from the Fed this year
• Market sentiment is improving amid softening inflation and robust housing and jobs data

In H1, the Nasdaq 100 (NDX) experienced an impressive gain of +39.4%, enjoying its best half-yearly performance since its inception in 1985. Additionally, the NDX showed its strongest relative performance compared to the S&P 500 (+16.9%), Russell 2000 (+8.1%), and the Dow Jones Industrials (+4.9%). This strong performance by the NDX sparked concerns among pessimists about its limited leadership and lack of market breadth, mainly when both the Dow Jones Industrials and Russell 2000 remained stagnant until the end of May. However, the market's breadth improved significantly in June, as the Dow Jones Industrials (INDU), S&P 500 (SPX), and the S&P 500 equal-weight (SPW) indices all achieved their highest monthly performance in 2023. 

Seven of the eleven sectors saw an increase in the first half of the year, with Technology, Communications, and Discretionary leading the way. The S&P 500 Technology Index, which is based on market capitalization, came close to reaching its previous all-time high from December 2021. However, it has since traded sideways, indicating a period of consolidation before potentially breaking through resistance. It's important to note that the Technology Index, when equally weighted, and the small-cap Russell 2000 Technology Index, also had respectable gains in the first half of the year. In mid-June, the S&P 500 Equal Weight Technology Index broke through a resistance level that had been in place for eleven months, reaching new 52-week highs. The Russell 2000 Technology Index is also approaching its eleven-month resistance level. 

During the first five months of 2023, the main reasons for the strong performance were technological advancements and expansion. However, there was a noticeable shift towards cyclical industries in June, possibly indicating improved economic activity. All eleven sectors ended the month with positive gains. The sector that performed the best was Discretionary, with a 12.1% increase, driven by Tesla and Amazon. This was followed by Industrials, which saw an 11.3% increase, and Materials, which saw an 11.1% increase.

Industrials is particularly noteworthy as it not only had a strong performance in June but also continued to rise in early July, reaching new record highs that were last seen in November 2021. The strong performance in June was supported by widespread participation, with 37% of its members reaching their highest levels in the past 52 weeks.

At the beginning of the year, numerous market analysts predicted an economic downturn caused by the delayed consequences of the Federal Reserve's continuous 15-month increase in interest rates. Adding fuel to the fire of a possible shortage of credit was the disturbance in the banking sector in March when four American banks and one European bank collapsed. The resulting instability in interest rates reached levels not seen since the global financial crisis; however, the MOVE Index has been gradually declining and returning to normal levels, partly because of the introduction of new measures to enhance liquidity by regulatory authorities. The decrease in bond instability is beneficial for overall market liquidity. 

US GDP for Q1 was revised upwards to 2% from 1.3%, with exports and consumer spending being the main drivers. Consumer confidence has been boosted, reaching its highest level since the beginning of 2022. This rise can be attributed to the strong labour market and the easing of inflation. The unemployment rate in May is still very low, matching the lowest levels seen in generations, and there has been an increase in the number of jobs in the residential construction sector. As seen in the core CPI and PPI, inflation is slowing down, but the Federal Reserve's preferred measurement, the core PCE, has remained high. 

The resolution to raise the debt ceiling caused worries that the resulting increase in debt issuance would deplete liquidity from the market, sparking more volatility and a decline in asset prices. However, the Federal Reserve's reduction of longer-term bonds through quantitative tightening, coupled with the majority of newly issued bonds being shorter-term Treasury bills, which money market funds mostly took up, has mitigated these concerns. The increase in short-term Treasury bill issuance and the subsequent decrease in the duration of bonds in the system may be pushing investors to take on more risk. 

Q2 company profits are predicted to fall for the third consecutive quarter. FactSet reports that the estimated decrease in earnings for the S&P 500 is 6.8%, which would be the most significant decrease since Q2 2020. The S&P 500's P/E ratio over the next 12 months is 18.9, compared to the 5-year and 10-year averages of 18.6 and 17.4, respectively.

The Federal Reserve did not increase interest rates at the June meeting, but policymakers have forecast two more rate hikes this year. The market is anticipating a rate hike at the upcoming July meeting, with a 40% chance of an additional quarter-point hike. In the past, the possibility of more rate hikes caused a decline in asset prices throughout 2022. However, Chair Powell has recently made more hawkish public statements, even though asset prices have remained stable. 

The markets are factoring in a more positive economic outlook than the media and market experts have been stating and predicting. The indexes have reached historic highs, the market breadth is improving, the industrial and homebuilder sectors are experiencing new peaks, the economic data is showing resilience, inflation is decreasing, corporate earnings are expected to improve in the second half of the year, and the potential impact of artificial intelligence revolution may indicate that the highly desired recession might not occur this year as initially anticipated.

During May, Australian bond yields ticked higher due to apprehension about the US debt ceiling talks, which conflicted with the inconsistent data from the global economy. The market tried to focus on the more optimistic data prints, overlooking signs of policy entanglement and concerns about inflation. As a result, there was a slight reevaluation of the terminal cash rate in Australia, which pushed short and long-term AU government bond yields higher across the curve. 

The RBA increased interest rates by 25 basis points to 3.85%, indicating that they would rely highly on data for future decisions. They no longer have a definite commitment to either pausing or increasing rates and would need to observe clear indications of decreases in inflationary pressure, particularly wages. The yields for AU3Y and AU10Y years rose by 37bps and 27bps, respectively, ending the month at 3.37% and 3.60%.

The focus of RBA Governor Lowe has shifted to four primary data indicators: retail sales, employment, the NAB business survey, and the Consumer Price Index (CPI). In May, the data was somewhat mixed. Although retail sales are returning to typical levels, the increase is being driven by prices rather than quantities. The May Australian employment data is starting to show signs of normalisation, with small employment growth and an increase in the headline unemployment rate. The NAB business survey is still exhibiting resilience, albeit slightly lower than before. 

Although the monthly CPI was slightly above expectations, it aligns with the decreasing headline CPI. The RBA has no cause for concern with the quarterly wage price data, which rose by 0.80% quarter on quarter (QoQ). However, they remain cautious about the annual award wage setting and rely on productivity as an indicator of potential inflationary wage growth. The initial impacts of policy implementation are noticeable, and the persistence of inflation may influence future policy decisions. 

The 90-day Bank Bill Swap Rate forecasts at least one more 25bps increase in the cash rate in the next 90 days. The 180-day paper currently yields 4.17%, implying a cash rate setting of 4.17% in that timeframe. 

May 2023 Summary:

• Global inflation is beginning to moderate
• Artificial Intelligence technology takes the world by storm
• US Tech outperforms Dow and Russell YTD, up over 30%
• US GDP grew by +1.3% in Q1, in line with expectations
• US corporate earnings have posted consecutive quarterly declines

Over the past few months, there has been a growing interest in the latest trend in business – Artificial Intelligence (AI). In May, the news was inundated with discussions about the growth potential of AI and its impact on the financial industry. 

During the month of May, Growth investments outperformed Value investments. The Russell 1000 Growth Index showed a gain of +4.6%, while the Russell 1000 Value Index displayed a loss of close to -3.9%. The Nasdaq 100 Index, which carries a significant focus on technology (leading to potential success in the AI discussion), demonstrated growth of +7.7%. Additionally, the tech index has risen over 30% YTD and reached a new high for the 52-week period this month. The Dow has remained unchanged throughout the year. Concerns have been raised regarding the market's breadth due to limited leadership and several negative technical indicators. 

As anticipated, the May Federal Reserve meeting resulted in a unanimous decision to increase rates by 25 basis points, bringing the overnight rate to 5.00-5.25%. During the subsequent press briefing, Fed Chair Powell stated that while the FOMC may opt to halt future rate hikes, it has no plans to decrease rates in the near future. This statement contradicts trading analysts' predictions that there will be three rate cuts by the end of the year, as evidenced by the Fed Funds Futures market. Powell did acknowledge that if the Fed's inflation forecast is accurate, it would be inappropriate to cut rates since it is uncertain whether 5.00-5.25% is "sufficiently restrictive." In addition, the task of achieving a restrictive stance is further complicated by credit conditions tightening after the banking crisis. 

US Bond Market:

Higher yields were evident across the curve in the US Treasury bond market. The US10Y increased to 3.64% from 3.43% at the end of April, while the US30Y rose to 3.86% from 3.68%. Short-term bonds also increased, with the US2Y trading at 4.40% by the end of May. However, some segments of the yield curve remain inverted, with US2Y treasuries yielding more than US10Y maturities. 

US Inflation:

The headline CPI for April met expectations, rising by +0.4% on a monthly basis and by +4.9% year-over-year, compared to March's +5.0%. Meanwhile, the Core-CPI, which does not include food and energy, saw a monthly rise of +0.4%, in line with analysts' predictions, and a year-over-year increase of +5.5%, with March's YoY increase at +5.6%. The largest contributor to the overall and core CPI increase was Shelter, which rose by +0.4% and saw the smallest increase since January 2022. The market views the continued moderation in inflation, including in the Shelter index, as potentially influencing the Federal Reserve to maintain its policy rate in its June meeting. 

Energy Markets:

Fears surrounding a drop in demand and a more robust dollar led to petroleum futures plummeting to their lowest point in the past few weeks. The market was left disheartened when Chinese factory output for the month underperformed market expectations, despite the end of policies related to COVID-19 in the nation. 

US Dollar Index:

The US Dollar Index rose by more than +2.5%, bucking the trend after posting two months of consecutive declines. Growth in employment figures and slightly increased inflation benefited the dollar, leading market pundits to consider the possibility of an additional rate hike at the upcoming June session of the Federal Reserve. 

The Months Ahead:

June is expected to bring several significant market events. On Friday morning (June 2nd), the May Jobs report will be published, with economists forecasting a rise in the unemployment rate to 3.5%. Additionally, the CPI will be released on June 13th, followed by the PPI on June 14th. The FOMC will announce their rate decision on the same day. On June 16th, the market will experience "triple witch" options expiration and S&P Index rebalancing simultaneously. The question remains whether the recent surge in tech stocks will spread to other sectors or if tighter credit conditions and slow Fed policy will negatively impact corporate earnings in the latter half of the year.

The RBA paused the consecutive run of interest rate rises in April, leaving the cash rate at 3.60%. However, they left a hawkish bias in the statement, paving the way for more tightening to bring the inflation rate back into the 2-3% target range. AU3Y and AU10Y government bond yields ended 6bps and 4bps higher, respectively, at 3.00% for the AU3Y and 3.34% for the AU10Y yields. 

On the data front, the NAB Business Conditions survey showed ongoing strength with above-average conditions, and the March labour market data came in hotter than expected, with 53,000 new jobs added and the unemployment rate steady at 3.5%. Annualised inflation in Australia is still well-above target at 7.0%, but prices are beginning to moderate slightly. Headline inflation added 1.4% over the March quarter.

Short-term interest rate futures are starting to price in more pauses from the RBA in the near term. 90-day bank bill yields trade at 3.68% (implying a cash rate of 3.68% in 90 days), while the 180-day bank bills trade at 3.86%. Some investment banks are still predicting a peak cash rate of 4.10% later in the year, but market expectations are beginning to pull back. 

In the credit markets, the focus has shifted from the US regional banking crisis to the US corporate earnings for Q1. Results have been solid thus far, but most are emphasising caution and uncertainty in the months to come. Many are speculating that the regional banking crisis may not be completely resolved with First Republic Bank's issues heavily circulated in the finance media in recent days. 

• Large-cap stocks are outperforming small-caps
• US Q1 corporate earnings are solid so far, with a cautious outlook
• M2 money supply declines while Gold breaks to new highs
• Credit default swaps trade higher in the US on debt ceiling woes
• Overall mixed data has led to mixed performance across assets

US Macro

US corporate earnings data is higher than the one-year averages, but many companies are revising outlooks lower for the remainder of the year. Stock price gains were also far lower for an earnings beat than in the previous four quarters, suggesting investor caution remains. The US debt ceiling woes continue to shake the market's confidence, with the CDS market trading to levels not seen since the GFC. 

US Growth

GDP in the US came in at 1.1% for Q1, which was far below the consensus of 2.0%, but this was not due to a decrease in consumer spending. PCE growth was 3.7% in Q1, up from 1.0% in Q4. Goods spending jumped 6.5%, and Services spending increased 2.3%. Annualised inflation ticked slightly lower to 5.0% and a 0.1% monthly increase. The March Core PCE ticked higher by 0.3%, which is the Fed's preferred inflation measure and is likely to keep the interest rate rises in the US coming in months to come. Personal savings rates in the US as a percentage of disposable income increased slightly to 5.1% in March from 4.8% in February, showing some concerns among consumers about an upcoming recession. 

US Equity Markets

Large-cap stocks outperformed small-caps on a total return basis in April, with the Dow Jones posting a 2.6% rise for the month, while the Russell 2000 fell 1.8%. The Nasdaq 100 gained modestly 0.5%, and the S&P500 lifted 1.6%. At the sector level, Energy, Consumer Staples, and Communications were the month's top performing, rising 3.6%, 3.3% and 3.8%, respectively. Consumer discretionary, Basic materials and Industrials were the worst-performing sectors in April.

M2 Money Supply and Gold

Gold is trading at all-time highs, while the M2 money supply is contracting for the first time after surging higher during the COVID pandemic. Government spending continues on an upward trajectory, corporate debt is rolling over on much higher interest rates, and homeowners with variable interest rates are seeing their repayments climb, all while banks are shoring up lending standards. These factors should encourage higher demand for US Dollars, which would typically be printed, but for the first time in history, we are seeing the money supply contract. The shortage could lead to an increase in defaults and potentially a recession, but with the current situation where the Fed is unlikely to ease policy in the near term, which is causing investors to pile into precious metals and commodities. 

The Months Ahead

The month of May begins with a US Fed meeting on the 3rd, where they are expected to raise interest rates by 25bps, bringing the cash rate to 5.25%. Other important economic data to watch are the CPI print in the middle of May, The Non-farm Payrolls and the GDP numbers to finish the month. The regional banking issues in the US will be closely watched as the FDIC tries to broker a deal for the First Republic Bank, and US corporate earnings will be another focal point in the weeks to come.

A developing banking crisis caused volatility to spike in March, leading to a drop in short-term yields and new monetary policies to try and stabilise the market. The long end of the yield curve benefited from a flight to quality, while equity and credit markets were choppy but found support late in the month. The Australian bond market had a strong month and rose 3.16%, as measured by the Bloomberg AusBond Composite 0+ Yr Index.

Early in the month, the RBA raised the cash rate by 0.25% to 3.60%, indicating that more tightening was possible. However, the bank's tone was less hawkish than February's statement. Due to banking sector stress outside of Australia, there was a significant drop in yields which caused markets to rethink their views on monetary policy and growth. As a result, the AU3Y and AU10Y government bond yields fell by 66 bps and 55 bps to close the month at 2.94% and 3.30%, respectively.

Although offshore events dominated the headlines, the latest economic data showed that the economy grew by +0.5% in the December quarter– continuing growth. The NAB Business Survey, conducted over January and February, showed strong business conditions. The labour market rebounded significantly in February, showing a potential upswing in the March quarter. Inflation in Australia appears to have peaked towards the end of last year; the yearly rate in February was still well-above target rate at 6.8%.

Short-term interest rate futures traded in a wide range in March, resulting in markets transitioning from expecting further monetary tightening to now expecting a peak cash rate of 3.60% for this cycle. Futures markets are also pricing in the chance of a 0.25% cut in the cash rate by the end of the year. 90-day bank bill yields were slightly higher than the cash rate, ending at 3.72%, while 180-day bank bill yields reflected the change in monetary policy expectations, ending 14.5bps lower at 3.79%.

The banking crisis in the US spread quickly to Europe, affecting the credit markets as well. During a single weekend, three US regional banks collapsed and Credit Suisse had to be taken over by UBS, causing the most significant period of financial sector stress since the Global Financial Crisis. Although there was prompt regulatory and government intervention and support, certain debt and equity holders suffered significant losses.

Due to the fast rise of interest rates in recent months, traders and hedge funds are searching for and exploiting vulnerabilities, leaving investors uneasy and evaluating if this caution will lead to stricter lending standards, resulting in a credit crunch that could severely impact economic growth.

• US equities had a solid consecutive quarter, with the S&P500 gaining +7.5% YTD
• Interest rate volatility climbed to the highest level in 15 years
• US regional bank stocks sold off heavily in March
• The Federal Reserve is battling to juggle inflation and volatile markets
• Oil markets surged on the back of an OPEC production cut

Capital markets experienced significant volatility in March due to the rapidly rising interest rate environment. Pressure on the banking system resulted in three regional banks closing down, Credit Suisse being taken over, government deposit guarantee plans being put in place, and the creation of a new lending facility for banks.

The stock market was largely mixed to close the month, but regional banks experienced the sharpest declines. The Regional Bank ETF (KRE) had its worst 3-day selloff since it began in 2006, dropping more than 27%. Its daily relative strength index (RSI), which measures momentum, reached a record low of 11.6. During this time, investors turned to safe investments like precious metals and large-cap growth, and defensive stocks. Small caps from almost all sectors (9 of 11) also had losses in March.

Volatility Index

Although there was significant volatility in certain areas of the stock market, particularly in banks, the VIX Index remained relatively stable. The index only reached a high of 26.52 in March and had three days where it closed above 25 before dropping below 19 at the end of the month.

US Equity Markets

In March, the Nasdaq 100 had the highest total return among major US indices at +9.5%. It had a great first quarter with a gain of +20.8%, its best since 2012. The S&P500 and Dow Jones Industrials also had strong monthly gains of +3.7% and +2.1%, respectively. The S&P 500 has gained +7.5% for the second consecutive quarter. Market statisticians have noted that historically if the S&P500 has gained more than +7% in Q1, it has never finished the full year lower. Out of the previous 23 instances of this occurring, there were two consecutive quarters where the gain exceeded +5%. One year later, the market finished higher 20 times with an average increase of +13.5%. However, the smaller cap S&P Midcap and Russell 2000 fell by 3.2% and 4.8%, respectively.

Equity Sector Performance

Sector performance differed significantly between large and small companies. Among the eleven sectors in the S&P 500, seven of the large-cap sectors showed growth, led by Technology and Communications. The Technology sector showed the most significant increase in Q1, mainly driven by the semiconductor industry, with the SOX Index having its most impressive quarter since June 2020 and its second-best quarter in 22 years. Utilities and Staples showed gains of +4.9% and +4.2%, respectively, while Financials declined by 9.6%. The Industrials sector is noteworthy since it is just under 3% away from 52-week highs.

US Interest Rates

The banking crisis caused a lot of volatility in the rates market. In March, the market was beginning to accept the Fed's plan of keeping rates high for a more extended period, but then suddenly changed its outlook and started to predict rate cuts as early as July. The November contract rate plummeted more than 185 basis points in only three trading sessions. Although rates have rebounded due to recent market stability and consistent inflation data, the chances of the first rate cut have been pushed back to September or November. Still, the situation could change quickly.

Oil Markets

Crude oil experienced a sharp drop in 2023, falling more than 16% YTD to its lowest point in 15 months. However, after a surge at the end of the month, it closed the month down only -1.8%. Oil markets jumped by around +8% over the weekend when OPEC+ made a surprise announcement of production cuts exceeding 1 million barrels of oil per day, led by Saudi Arabia with 500,000 barrels. The increase in energy prices is a problem not only for the Federal Reserve's efforts to control inflation but also for the Biden administration due to the fact that the Strategic Petroleum Reserve has decreased by 222 million barrels (from 594 million to 372 million) over the past 15 months since the start of 2022.

Precious Metals

The prices of precious metals increased, with spot gold and silver increasing by +7.8% and +15.2% YTD, respectively. Gold ended the month at $1,969, trading higher than its 2011 peak and only 6% away from reaching new all-time highs. In March, the US Dollar Index (DXY) dropped by -2.3%, marking its fifth decrease in the past six months.

The Months Ahead

The US Fed is facing a dilemma as stresses in the banking system have made it hard to balance price stability and financial stability. Recently, they increased rates by 25bp, making it a total of 19 rate hikes in the past year. Despite Chair Jerome Powell stating that the banking system is stable, he also mentioned that the committee is considering the real economic impact resulting from the stresses in the banking system through the lending channel. There is a 55% - 65% probability for a 25 basis point rate hike. However, there is increasing talk about the timing and speed of the Federal Reserve's rate cuts. According to their economic projections, they anticipate keeping rates around 5% until the end of 2023.

February 2023 Summary:

• Interest rate expectations turned higher once again
• Employment was strong, while inflation remained sticky
• Labour market data remained strong alongside inflation
• US corporate earnings ticked lower for the first time since late 2020
• Commodities sold off heavily in February with the Energy sector the hardest hit
• Gold markets experienced a sharp sell-off during the month

In January, the stock market had a strong rally after the Federal Reserve's expectations to ease the rate trajectory. However, February brought an entirely different perspective; The Fed raised the benchmark rate by 25bps up to 4.75%, with further increases of 25bps anticipated in March and May as well. This created a shift from expecting rate cuts late in the year towards keeping them higher for longer - something that was not priced into markets previously. The terminal rate in the US has jumped to approximately 5.4%. This surge in rate expectations was mainly due to the impressive job numbers, with Change in Nonfarm Payrolls clocking a stunning +517K - way beyond the expected 189K figures. Average hourly earnings maintained its above-average 4.4% YoY, particularly within Leisure and Hospitality, which saw an incredible 7% gain.

After the hot jobs report, inflation data reported mostly in line with expected MoM readings, though services inflation stretches higher than usual. Prices for housing saw a dip as mortgage rates inched up, while commodities continued to drop lower. January's CPI registered 0.5%, which was equal to expectations and 6.4% YoY, outperforming predictions of 6.2%. 

In addition, the January PPI data was hotter than anticipated, with monthly growth of 0.7%, exceeding the expected 0.4%. The YoY results also outshone expectations, coming in at 6.0% compared to 5.4%. Similarly, underlying PCE figures were higher than forecasted too - recording an increase of 0.6% from last month and giving a YoY figure of 5.4%, versus a predicted 5%.

FOMC:

February was a month filled with economic data and FOMC rate decisions, as well as 4Q '22 earnings prints. This time around, the market responded positively to earnings surprises by rewarding those companies who posted higher-than-expected numbers with an average price increase of 1.1% over four days (above their 5-year average of 0.9%). On the other hand, any negative surprises weren't punished nearly as harshly; instead, seeing a decrease of just 0.6%, compared to its usual -2.2%.

US Equities:

For the month, large-cap growth stocks were the relative outperformers, with Nasdaq 100 only falling by -0.4% and the Russell 1000 Growth index dropping -1.2%. Large-cap value stocks took a harder hit as they dropped by -3.5%, while the Russell Microcap index fell -2.9%. The energy sector was notably weaker, dropping -7.1%, followed closely by REITs and Utilities, which decreased by -6.2% and -5.9%, respectively.   

US Earnings Data:

S&P 500 companies' Q4 earnings reports have proven to be underwhelming, with 96% of firms having revealed their results. Only 68% of companies reported higher-than-expected EPS, lower than the respective 5 and 10-year averages at 77%, and 73%. It's worth noting that the average EPS beat was about 1%, which is significantly less than the 5/10-year averages of 8.6%, and 6.4%. The Communications sector has been a major contributor to weak overall earnings figures; however, Consumer Discretionary outperformed expectations by considerable margins in comparison.

Mortgage Markets and Rates:

The US2Y/US10Y spread continued its inversion, closing out the month at -89bps. After staying relatively stable since 4Q '22, the yield of the US2Y bonds suddenly skyrocketed to a record high near 4.8%, while the US10Y bond yields stayed below their October '22 highs and eventually settled around 3.92%. During the month, mortgage rates in the US soared to around 6.8% for a 30-year fixed rate. The S&P/Case-Shiller U.S. National Home Price Index (non-seasonally adjusted) observed an annual gain of 5.8% in December (3x average closing prices from October, November and December).

The Months Ahead:

March is full of noteworthy events, with the FOMC decision on the 22nd being one of them. The market anticipates a 25bp raise from the committee, but according to recent Federal Reserve minutes, some members favoured a 50bp increment during their February session. Two crucial data releases are slated; Nonfarm Payrolls numbers will be revealed on the 10th, while Consumer Price Index (CPI) follows suit approximately four days later - and don't forget that both were pleasantly surprised in February. Equities sold off sharply when bond yields rose in February, meaning bonds will continue to dictate equity prices in the short term.

Despite slipping out of the international spotlight, the conflict in Ukraine is still a dangerous reality that could very easily cause markets to crash if tensions continue to rise. To make matters worse, recent events such as China shooting down an alleged "spy balloon" have further strained relations between these two major powers. Any more issues on this front would wreak havoc with global trade activities.

January 2023 Summary

• Cooling inflation data and China re-opening help drive equity rally in January
• Nasdaq 100 posts best monthly performance in January since 2001
• Corporate earnings in the US continue to cool off
• The yield curve in the US remains inverted

US equities made a strong comeback in January following their disappointing results from 2022. A confluence of events generated optimism amongst investors, including inflation data that suggested a soft landing for the US economy instead of an extreme recession. Moreover, a weaker dollar and loosening trade restrictions between China and other countries contributed to more favourable business conditions, further bolstered by falling energy prices and lower corporate earnings expectations.

January proved to be a profitable month for the Nasdaq Composite, with its 10.7% gain being its highest since 2001 after falling by an impressive 32% in 2022. Not only did all major indices post positive returns during January, but they are now also trading above their 200-day moving averages - typically a display of market strength that may continue into February and beyond.

On a total-return basis, the Nasdaq 100 Index and Composite gained over 10.7%, the S&P 500 returned 6.3%, Dow advanced 2.9%, and Russell 2000 rose 9.7%. Consumer Discretionary, Technology, and Communications stocks that were laggards in 2022 saw significant gains in January.

Treasuries

In January, US Treasury yields weakened across the entire curve. The yield on the benchmark US10Y Treasury has decreased to 3.51%, falling from its October peak of 4.25%. More impressively, since November, the US30Y yield has remained below 4% and is currently sitting at 3.64%. Due in part to a strong equity market run this month so far, even the US2Y have seen yields decline, with rates now standing at 4.21%. Many parts of the curve are still inverted, which has been a recession predictor in the past.

Earnings commentary

A little over a third of the S&P 500 companies have reported their Q4 profits, with an unexpected 5% decline in comparison to the 3.2% decrease initially predicted. Profits are anticipated to remain subdued for both Q1 and Q2 by around 2-3%. However, there should be some respite from mid-year onwards as earnings growth is forecasted at 3.4%, along with revenue expansion estimated at 2.6%.

Bloomberg data reveals the average beat of earnings for this quarter was 2.83%, and sales increased a positive 1.06%. The rate of growth in earnings rose to 3.70%, with Utilities driving up sales growth by 7%. Energy, Industrials and Consumer Discretionary boomed with increases at 78%, 54% and 32%, respectively, while Materials crumbled at -43%, Communications slipped -15%, and Financial dropped -13%.

Volatility

As the end of January approached, market volatility declined sharply as investors and the Federal Reserve aligned their projections for future interest rate rises. This can be seen in the CBOE Volatility Index (VIX), which dropped 11% over this period from 23.76 on January 3rd to a low of 17.97 intraday on January 27th before closing at 19 by month's end.

Oil Market

Oil prices have been on a downward trajectory for nearly eight months, with the exception of January, when it experienced an 8% surge from its early month lows. In March of 2022, WTI hit a 14-year high of $123.70; however, compared to last year's figures, oil is down 10% and overall 23% since that peak.

Gold Prices

The price of gold rose steadily over the past three months, trading to a high of nearly 7% in January before closing the month up 5.7%. However, since its peak at $2,050 in March 2022, Gold has declined by 5.9% from these levels.

US Dollar

For four months in a row, the US dollar edged lower due to speculations that central banks will reduce interest rate hikes as inflationary pressures start waning. The US Dollar Index dropped 1.35% in January and has fallen 10.5% from its September 2022 peak of $114.

Cryptocurrency Markets

Despite FTX's collapse causing ongoing uncertainty in the crypto space, volatility continues to be influenced by a range of factors. Inflationary pressures coupled with central bank policy have had an impact on prices - Bitcoin dropped over 60% in 2022; however, it rebounded at the start of 2023, rising 39% so far. These developments are mirrored across other equity markets.

The Months Ahead

On February 1st, the FOMC unveiled their target interest rate range. Investors focused on Chairman Powell's post-release interview in order to gain insight into inflation commentary, a higher for longer approach and if there is any potential for a rate reduction later this year. After the FOMC rate decision on February 1st, the January jobs report (2/3), CPI (2/14), retail sales (2/15) and producer price index (2/16). Since 1929, 80% of annual equity market returns have been positive after stock prices increased in January.