ARTICLES

As predicted by many, the Reserve Bank of Australia lifted the cash rate in early November by 0.25%, raising it to 2.85%. The RBA made it clear that although monetary policy was not set on a particular path and further tightening was probable in the near future. Yields rose in unison early in the month after messaging from central banks, particularly the US Federal Reserve, gave assurances that rates would continue to rise. However, following cooler-than-expected inflation readings, markets began to doubt how much or how quickly rates would continue to rise, and yields drifted lower as a result.

Volatility was at the forefront in October, with bond yields rallying on a surprisingly hawkish US Federal Reserve, which caught the market offside after many thought inflation had peaked. Equity markets found some support after the selloff in September, with many benchmark indices posting their best monthly performance in some time. In Australia, the bond market rose by +0.92% (Bloomberg AusBond Composite 0+ Yr Index). 

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.

August saw the RBA raise the cash rate by another 0.5% which was widely anticipated to 1.85%. Yields rallied in Australia and worldwide later in the month on the back of increasingly hawkish central bank commentary and persistently strong economic data. The 3Y AU Government bond closed the month at 3.2%, while the 10Y (+53 bps) and 30Y (+38 bps) yields closed higher at 3.6% and 3.8%, respectively.

Markets were beginning to think inflation was starting to moderate, and central banks may have to reverse course in August, which guided equity markets higher during the first half of the month. This came crashing down after a hawkish speech from the US Fed chair at Jackson Hole, causing markets to sell off around the world after a strong start. The ASX 200 closed the month at basically flat 6,986 points. The Nasdaq 100 gave back -5.2%, and the Nasdaq Composite fell by -4.6%. The S&P 500 shed -4.2%, and the Dow Jones was softer by -4.1%. The Russell 2000 was one of the relative best performers on the month, losing only -2.2%.

The Australian July Unemployment reading (released in August) came in at 3.5%, slightly lower than the previous month (3.6%). However, the data seemed somewhat skewed due to a dramatic fall in the participation rate (-41,000 jobs) due to COVID illness and school holiday timing. Rising labour costs continue to be a talking point, with wages rising by +0.7% over the quarter and currently sitting at 2.6% annualised.

The July reading of the NAB Business Conditions survey remained high, with capacity utilisation and overall business conditions significantly above long-term averages. Consumer sentiment, however, has fallen to pandemic lows with the rising cost of living starting to hit home. Retail Sales data came in at 1.3% for the month, showing that spending patterns still haven't slowed. Australian interest rate futures are now pricing a cash rate of 3.2% by the end of 2022 and a 3.85% cash rate by the middle of 2023. 90-day bank bill yields sitting at 2.45% (+34 bps), while the 6-month bank bills have a yield of 3.0%. 

August 2022 Summary

• The US Dollar now trades at a 20-year high
• US yield curve has remained inverted in August
• Stock markets sold off late in the month after a strong start 
• US CPI sits at an annualised rate of 8.5%, after a 9.1% peak in June
• Central Banks are willing to risk a hard recession to tame inflation 

After bottoming in June, Equity prices steadily increased throughout July and early August. This was in part due to the misperception that inflation had peaked. From the low in June to the high in Mid August, the S&P 500 Index saw returns of over +17% and the Nasdaq 100 Index did even better, with 21% growth during that time. However, this rally came to an end on August 26th with its untimely demise attributed to Federal Reserve Chairman Powell's hawkish speech given at the Jackson Hole Economic Symposium later that day.

The Federal Reserve will continue to employ tight monetary policy "for some time" to bring down inflation, according to Chair Powell. He also warned that switching course too soon may result in similar levels of inflation experienced four decades ago when inflation reached above 14% in 1980. The Chair added, "While higher interest rates, slower economic growth, and softer labour market circumstances will reduce price inflation, they will also cause pain for households and companies. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain."

US Government Bonds

The current yield on the benchmark US 10Y Government bond is 3.12%, down from its June peak of 3.49%. The US 30Y yield traded back above 3% early last month and remained higher at 3.22%. Yields on shorter-term US 2Y touched 3.50% after Powell's comments at Jackson Hole, which matched the highest rate since the GFC in 2008. The US 2Y yield is currently higher than the US 10Y yield, meaning that the yield curve remains inverted, which has been a signal for a recession in the past.

Volatility Index

Volatility measured by the VIX index lifted after Fed Chair Powell's speech at Jackson hole late in the month of August to close around the 26 level. The VIX index, often referred to as the "Fear and Greed Index", was below 20 around the middle of the month. A lower VIX index is typically supportive of risk appetite. 

Petrol Prices

The average cost of a gallon of regular gasoline in the US is now at $3.83, down 9% on the prior month or 0.37 cents, according to AAA data. Oil prices traded lower in the month of August, falling 7.4%. West Texas Intermediate (WTI) touched a high of $123.50 in March this year, which was 14-year highs (now -25% from that point). 

The US Dollar 

Hot inflation and the rising rate environment have continued to give wings to the US Dollar rally. The Greenback, which is the world's reserve currency, traded to 20-year highs above $109 during the month. The US Dollar Index is +13% since the start of 2022. 

Bitcoin

Since the all-time highs in November 2021, Bitcoin is down over -70%. The virtual currency traded up +3% during the start of August before reversing with the risk-off swing to close the month -15%. 

The Months Ahead

The Equity market rally spurred by the peak inflation theory reversed at the end of the month. Fed Chair Powell's aggressively hawkish speech on inflation, markets and jobs caught the market by surprise, and the sellers were in control to close out the month. The next set of important economic data out of the US will come later in September, with the interest rate decision on the 21st and the CPI reading on the 13th.