The final week of the third quarter capped off a miserable period for equity markets, with most indices adding to losses for the quarter. Focus was on the United Kingdom, as the Bank of England (BoE) was forced to take emergency action to address fears of systemic risk in certain areas of the pension system following gilt market turmoil. In addition, the geopolitical backdrop deteriorated further as Russia claimed to annex the areas of Ukraine it still holds, Russian President Vladimir Putin doubled down on his anti-West rhetoric and the Nord Stream pipeline was the victim of sabotage. In that context, the MSCI World Index fell 2.4%, the S&P 500 Index fell 5.2%, the STOXX Europe 600 Index fell 0.6% and the MSCI Asia Pacific Index fell 4.2%.1
On the quarter, the MSCI World Index fell 6.5%, the S&P 500 Index fell 5.2%, the STOXX Europe 600 Index fell 4.8% and the MSCI Asia Pacific Index was a clear laggard, down 12%. European and the US equities have seen three consecutive quarters of negative performance, which we haven’t seen since the global financial crisis.
Tumultuous week for UK assets
Last week, the United Kingdom took centre stage for all the wrong reasons. Following the controversial “fiscal statement” from the UK government on the prior Friday, financial markets took fright at the sweeping range of unfunded tax cuts and spending proposals, as many felt the plans lacked in detail and costing. Recall, the UK’s Office of Budget Responsibility (OBR) would normally be called to objectively review and comment on a policy development like this, but the government declined this analysis. Furthermore, Chancellor Kwasi Kwateng added to the sense of unease by subsequently commenting there was “more to come” in terms of tax cuts.
In that context, the British pound fell to an all-time low versus the US dollar (1.035) in early trading last Monday and the UK gilt market went into something of a meltdown. The UK 10-year yield traded above 4% for the first time since 2010 and above the US 10-year Treasury yield for the first time in eight years (3.75%). In particular, it was the long end of the gilt market that caused the largest problems. The 30-year yield moved from 3.5% to 5% following the budget announcement, and these extreme losses initiated margin calls on heavily exposed UK pension funds (called “pension liability driven funds”).
Essentially, the problem relates to margin requirements when there’s a large bond selloff and the associated liquidity/collateral shortfalls. The need to raise cash to post margin on these bond portfolios means these funds face growing pressure to sell existing assets irrespective of lower prices.
In the face of a systematic risk to the UK pension market, the BoE announced on Wednesday it would step in to buy longer dated gilts at “whatever scale necessary” due to “material risk to financial stability”. It confirmed it planned a further £65 billion of bond buying. This is even more remarkable given it had been scheduled to start quantitative tightening this week, which is clearly now on hold. The long-dated 30-year yield pared back significantly to 3.8% (the largest drop since 1996), so as a temporary solution the BoE succeeded. The pound also recovered ground on the week.
It is also worth noting that there was a negative global reaction to the UK government plans. The International Monetary Fund took the unusual step of commenting on the announcement, stating: “Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy”. We also saw credit ratings impacts. Moody’s said that it had concerns around the credibility of the UK government’s fiscal strategy that could “permanently weaken the UK’s debt affordability”.2S&P put the United Kingdom on a “Negative Outlook” due to new “additional risks” following the fiscal statement.3
There are fears that the UK crisis could lead to contagion in bond markets globally. This is a key dynamic to watch going forward.
Sentiment on UK assets is in the doldrums. UK-focused funds have seen $16.8 billion outflows year to date, and are on track for worst year ever. 4 In addition, short interest on the FTSE 250 Index continues to trend higher.
In that context, last week saw the domestic-focused FTSE 250 Index fall 4.4%. The FTSE 100 Index was somewhat insulated from the declines, thanks to its US dollar earners and international exposure.
A couple of final points on the United Kingdom. First, the impact on consumer finances, as the mortgage market saw a fair amount of turmoil last week. A number of providers have pulled their mortgage products to rebase rates higher in response to the current climate. For example, if interest rates rise as predicted, the average household refinancing a two-year fixed rate mortgage in the first half of next year would see monthly payments jump to £1,490 from £863.5 Secondly, it will be interesting to see if we have further UK merger & acquisition activity, given the pound is down 20% year to date.
Looking ahead, we have a lot of UK dates to watch.
- 3 October: Conservative party conference. Liz Truss speech is on 5th.
- 7 October: OBR to publish its first iteration of fiscal forecasts.
- 14 October: End temporary buying.
- 31 October: Start quantitative tightening at now faster pace
- 3 November: BoE meeting. There had been talk of an ad-hoc rate hike earlier in the week, but the BoE suggested it was unlikely to do this.
- 23 November: Another budget/fiscal statement.
U-turn: The UK government this morning announced an about turn and will no longer lower the higher tax band from 45% to 40%. Liz Truss faced a humiliating back bench revolt against the policy and appeared to have no alternative. The pound advanced, and the BoE rate-hike expectations have eased back a bit.
The week in review
Last week was tough for European equities as the STOXX Europe 600 Index fell through a key support level at 400 and made 52-week lows. Spanish and Italian equities fared the worst, while French equities outperformed, albeit still with mild losses.
Inflation data was front and centre amid the release of September Consumer Price Index (CPI) reports across the region. Overall, the picture was mixed. The eurozone CPI and German CPI reports both saw higher than expected inflation readings, but French CPI was lower than anticipated.
Bank stocks are in focus amidst trouble at Credit Suisse. Its credit default swaps widened and share price hit all-time lows. Meanwhile, EU gas prices continued to fall despite damage to the Nord Stream pipelines.
US equity markets struggled for support last week amidst tighter financial conditions and an unrelenting global rate hike cycle. The S&P 500 Index closed last week down 2.9%. The CBOE VIX Index traded through 34 for a short period on Tuesday—marking an increase in volatility.6 There was little macro news out of the United States, with much of the focus on events in Europe and China. In terms of sectors, energy was the only one to finish higher last week amid a small rise in spot oil prices. Utilities were the notable laggard.
Rallies continue to be sold, with any bounces attracting a lot of scrutiny, even as oversold conditions persist. There are still doubts that we have seen enough capitulation to drive a credible bounce. Upcoming earnings season is starting to come into focus, with more corporate announcements continuing to disappoint last week.
Sentiment continues to be very bearish. Depressed sentiment indicators continued to be flagged as contrarian buy signals; however, they are struggling for traction, given the number of bearish drivers out there. Finally, the CNN Fear and Greed Index remains firmly in “Extreme Fear” territory.7
One point of optimism we would note: September is usually the worst month of the year for equity market performance, so perhaps there is a reason to expect a year-end rebound.
In terms of data, the US Personal Consumption Expenditures inflation report came in higher than expected at 6.2%, but did show a drop from the previous month, which was a small positive for sentiment last week.
Last week was another poor one for Asian equities, with the MSCI Asia Pacific Index declining 4.25%. Japan’s market was the worst regional performer, down 4.48% last week, hitting a three-month low, amid fears about an impending global recession amidst rising interest rates and inflation. Of the major markets, Australia was the relative outperformer, closing down 1.53% last week.
Last week saw the release of minutes from the last Bank of Japan (BoJ) meeting, which showed an 8–1 vote to maintain a negative benchmark interest rate of -0.1%. The BoJ also confirmed that it will continue to purchase a necessary amount of Japanese government bonds (JGBs) without setting an upper limit, to maintain 10-year JGB yields at around 0%. The yen weakened further as a result against the dollar.
Elsewhere, Japan’s industrial production and retail sales figures for August both beat expectations, while the jobless rate fell to 2.5% in the month.
Sector-wise, Japanese shipping names fared worst amid concerns about a global slowdown in container shipping.
China’s equity market closed last week down 2.1%, as a stronger US dollar overshadowed sentiment.
Sector-wise, health care stocks outperformed last week, as several cities experienced COVID-19 outbreaks and lockdowns. Despite that, tourism-related stocks actually performed well in anticipation of consumer spending during the upcoming Golden week holidays.
The yuan fell to a 28-month low last Monday and has lost more than 11% against the dollar this year. In this context, the yuan is on track for recording its biggest annual loss since 1994, when China unified its official and market rates, according to Reuters. Like many emerging markets currencies, the yuan has weakened against a surging dollar, amidst aggressive interest rate hikes from the Federal Reserve (Fed).
Looking at macro data, industrial profits fell 2.1% in the first eight months of the year from the prior year period. The Caixin/Markit manufacturing Purchasing Managers Index (PMI) fell to a worse-than-expected 48.1 in September. Meanwhile, China’s official manufacturing PMI slightly improved in September, but services sector activity contracted as ongoing covid lockdowns continued to hurt consumer spending.
Hong Kong’s equity market fell 3.9% last week to trade at a decade low, as risk aversion continued to rule the local equities market amid heightened fears of a global recession, weakening yuan, and a persistent hawkish tone from the Fed. There were some positive performers, as Macau casinos were among the biggest gainers after the government announced they now welcome back tour groups from mainland China.
The week ahead
European markets were off to a weaker start to the quarter, with banks taking a hit from concerns around Credit Suisse. Looking ahead, it will likely be a quieter week with many Asian market closures due to Golden Week.
In Europe, focus will also be on Russia’s reaction to Ukraine military gains over the weekend. We also see minutes from the last European Central Bank meeting, and European Union leaders meet on Friday. From a UK perspective, all eyes will be on the Conservative Party Conference.
In the United States, there are several Fed speakers through the week, and then on Friday, September employment data will be released.
Monday: China, South Korea
Tuesday: China, Hong Kong, Tel Aviv
Wednesday: China, India, Tel Aviv
Monday 3 October
- Eurozone S&P Global Eurozone Manufacturing PMI, France S&P Global France Manufacturing PMI, Germany S&P Global/BME Germany Manufacturing PMI, UK S&P Global/CIPS UK Manufacturing PMI, US construction spending, US ISM Manufacturing
- Fedspeak: Raphael Bostic, John Williams
- UK Conservative Conference: key speeches are Chancellor Kwarteng on Monday (~16:00 UK), and PM Truss on Wednesday
Tuesday, 4 October
- Macro: Eurozone PPI, Japan Tokyo CPI, Spain unemployment, US factory orders, US durable goods
- Fedspeak: Lorie Logan, Loretta Mester and Mary Daly Speak
- Reserve Bank of Australia is likely to raise rates by 25 bps at its October meeting
Wednesday, 5 October
- Macro: Eurozone S&P Global Eurozone Services PMI, EIA crude oil inventory report, France industrial production, Russia gross domestic product, US trade data, OPEC+ meeting starts (potentially to cut oil production again)
- Fedspeak: Raphael Bostic speaks
- OPEC+ coalition meets
Thursday, 6 October
- Macro: Eurozone retail sales, ECB minutes, Germany factory orders, Spain industrial production, US initial jobless claims
- Fedspeak: Charles Evans, Lisa Cook, and Loretta Mester
Friday, 7 October
- Macro: France trade data, Germany industrial production, US unemployment, US wholesale inventories, US September Employment Report
- Fedspeak: John Williams
- EU Leaders meeting in Prague
Views you can use
Our Head of European Fixed Income, David Zahn, weighs in on the potential market implications of the outcome of the recent Italian elections. Read more.
Why is the US dollar so strong? And what does the strengthening dollar mean for investors, the global economy and inflation? Stephen Dover, Head of Franklin Templeton Institute, explains. Read more.
The municipal bond market has not been immune to bouts of volatility hitting the markets this year, but there are still pockets of opportunity, according to Franklin Templeton Fixed Income’s Director of Municipal Bonds, Ben Barber. He points to improving technical conditions, stable fundamentals and inexpensive valuations that make the asset class look compelling. Read more.
China’s equity market has had a volatile year, but Dina Ting, Head of Global Index Portfolio Management, Franklin Templeton Exchange-Traded Funds, finds reasons for long-term optimism. Read more.
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1. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. Source: Moody’s, “Government of the UK: Large unfunded tax cuts are credit negative,” 29 September 2022.
3. Source: Reuters, “S&P cuts UK rating outlook after tax cut plan,” 30 September 2022.
4. Source: Bloomberg. “UK Stocks Set for Record Outflows in a 2022 Meltdown, BofA Says,” 30 September 2022.
5. There is no assurance that any estimate, forecast or projection will be realised.
6. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Often called the “fear gauge”, lower readings suggest a perceived low-risk environment, while higher readings suggest a period of higher volatility. Indices are unmanaged, and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
7. CNN’s Fear & Greed Index tracks seven indicators of investor sentiment. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.