The digest
After a quiet start, a flurry of mid-week macro news and central bank announcements gave investors plenty to digest last week. The Federal Reserve (Fed) and Bank of England (BoE) largely stuck to their scripts from prior meetings, albeit with a more hawkish tilt from the Fed. However, the European Central Bank (ECB) struck a far more hawkish stance than the market had anticipated, and this spooked investors. With that, European and US equities slumped into the end of the week, and the MSCI World Index ended the week down 2.1%, the STOXX Europe 600 Index fell 3.3%, the S&P 500 Index fell 2.1% and the MSCI Asia Pacific Index fell 1.7%.1
Coming into year-end, the year-to-date declines are bruising, with the MSCI World Index down 19%, the STOXX Europe 600 Index down 13%, the S&P 500 Index down 19% and the MSCI Asia Pacific Index down 19%. Bonds have also suffered, with the Bloomberg US Treasury Index down 10.7% year to date.
Central banks: ECB out-hawks the Fed and BoE
Central bank meetings featuring the Fed, BoE and ECB were in focus last week. In addition, inflation data released last week likely helped feed into the central banks’ decisions.
United States: The US November Consumer Price Index (CPI) data was released on Tuesday and was lower than expected, with headline November CPI and core CPI (excluding food and energy) easing to 7.1% and 6.0% respectively, down from 7.7% and 6.3% previously. This news brought some optimism that the Fed could strike a less hawkish tone at its policy meeting on Wednesday.
The Federal Open Market Committee (FOMC) raised rates by 50 basis points (bps) as expected, slowing from its recent 75 bps pace. The meeting statement was nearly unchanged from November, with no change to language saying “ongoing” rate increases may be appropriate (vs expectations for some softening). The decision was unanimous.
There was more attention on the new Summary of Economic Projections (SEP), which showed median policymaker projections for 2023 rates up to ~5.1% from the ~4.6% in September’s edition, higher than some analysts’ forecasts. The 2024 projections were also more hawkish that expected, with the median forecast for the end-2024 rate raised to 4.125% (prior 3.875%), which was significantly above market pricing for the rate path. The SEP also showed lower forecasts for 2023 gross domestic product (GDP) and higher Personal Consumption Expenditure Index inflation expectations.
Fed Chair Jerome Powell was clear further rate hikes were required, repeating the “ongoing” rate path language from the statement. He also said in the press conference that “we have more work to do” on interest rates.
Fed fund futures are now pricing in a peak rate of 4.843% in May, lower than the Fed’s “dot plot” prediction.2 We would expect Fed policy to remain a key focus for investors well in 2023.
In the immediate aftermath of the Fed decision last week, the market’s reaction was not too extreme, as the S&P 500 Index closed down just 0.6% on Wednesday. However, after the ECB’s hawkish statement the following day, US markets followed Europe down further into the end of the week.
ECB: On Thursday, the ECB came out with a more hawkish statement than anticipated. It raised rates by the expected 50 bps, leaving the benchmark policy rate at 2%, but the commentary that accompanied the decision was much more hawkish. ECB President Christine Lagarde stated: “Anybody who thinks that this is a pivot for the ECB is wrong… We should expect to raise interest rates at a 50 [basis-point] pace for a period of time.”3
In addition, quantitative tightening is to start in March 23, earlier than anticipated. The ECB’s core inflation projection is at 2.4% for 2025. Growth in 2023 is projected at 0.5%, and then headline at 2.3% in 2025. The central bank sees a “short-lived and shallow” recession. Traders have subsequently added to rate-hike bets, with the market pricing a deposit-rate peak of 3% next year.
The equity market’s reaction after the meeting was a swift move lower. In addition, European sovereign bonds yields widened, as have credit spreads (although credit is still much tighter than levels seen earlier in the year). With quantitative tightening now scheduled to start in March 2023, we think European markets will put greater scrutiny on sovereign yields, particularly highly indebted Italy, for example.
BoE: The BoE interest-rate decision and statement were broadly as expected. The BoE lifted its benchmark interest rate 50 bps to 3.5%, the highest rate in 14 years. We have seen nine consecutive meetings resulting in hikes (the longest run since 1989). There was some ambiguity as the vote was a three-way split on the monetary policy committee (MPC), with six votes for 50 bps, two for unchanged and one for 75 bps.
On the inflation outlook, the central bank sees inflation “very high” in the near term but falling sharply from mid-2023 and “some way below” target from 2024. BoE Governor Andrew Bailey stated that inflation may have peaked, noting November’s UK CPI reading was lower than expected, at +10.7%. However, the BoE repeated that “if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary”.
Week in review
Europe
European equities finished last week down 3.3%. The week was littered with high-profile central bank announcements and inflation reports, as noted, key driving factors for markets in 2022. Wednesday’s FOMC announcement preceded the ECB and BoE announcements on Thursday. Between those three, there were no surprises in terms of rate hikes, all raising rates 50 bps as expected. However, it was the finer details and the following commentary which spooked investors. ECB President Christine Lagarde told investors to prepare for a long run of interest-rate hikes to curb inflation in the eurozone. Also, whilst the BoE announcement was viewed as slightly dovish in its vote, the MPC still guided toward further hikes, with language unchanged.
The market setup into the week goes a long way to explain the move lower after the rate-hike announcements. The STOXX Europe 600 Index was having its best fourth-quarter performance since 1999, with positioning and sentiment more balanced than it had been throughout the start of the year. Market volatility had fallen back to year-to-date lows. Thursday was the worst session for European equities since May and the STOXX Europe 600 Index traded back below its 200-day moving average, which is an important technical level.
All sectors in Europe closed last week lower. The rate trajectory and central bank hawkishness helped bank stocks outperform, albeit still down last week overall, whilst real estate stocks were amongst the worst-performers last week. Also, European-focused equity funds recorded their 44th consecutive weekly outflow.
European energy looks resilient: The fall in European gas futures prices is a positive that the central bank news has overshadowed. Prices have fallen 26% month-to-date in December4 on news the cold snap across Europe looks set to ease and gas reserves have held up well. European reserves sit at 85% capacity, which is comfortably higher than historic averages thanks to record inflows of liquified natural gas. German reserves are still 90% full.5
Furthermore, the European Union (EU) is considering a lower gas price cap. The Czech government, which holds the EU’s rotating presidency, has suggested lowering the ceiling to €188 per megawatt-hour, compared with the €275 the European Commission proposed last month.
Looking to macro data, the eurozone flash composite Purchasing Managers Index (PMI) contracted less than expected in December, hitting a four-month high. Eurozone PMI hit four-month high of 48.8 versus 47.8 prior. Both manufacturing and services saw improvement. The manufacturing PMI stood at 47.8 versus 47.1 prior, while services stood at 49.1 versus the prior 48.5.
United States
US equities closed last week lower amidst the hawkish Fed meeting. The S&P 500 Index was down 2.1%, the Nasdaq was down 2.8% and the Russell 2000 was down 1.9%. Outside of the Fed, there was very little for the market to get excited about last week. Volumes should drop off dramatically through the upcoming holiday season.
Market sentiment still points to bearishness overall, with the CNN Fear and Greed Index pointing to “Fear”.6 Energy was the only sector to finish higher last week, amidst higher crude oil prices. The sector is the only one up year-to-date.
Markets received a shot in the arm on Tuesday, with the latest US CPI report coming in weaker than expected and representing the smallest monthly increase this year. Headline CPI rose 0.1% in November and is up 7.1% on the year, down from 7.7% year-over-year in October. Headline CPI has fallen from a peak of 9.1% in June, mainly due to lower energy prices. Core CPI, which excludes food and energy, was up 0.2% month-over-month and up 6.0% year-over-year after a 6.3% increase in October. The key shelter component remains elevated, however.
The S&P 500 Index was up 2.7% at one point during early trading on Tuesday after the softer November CPI reading. However, the market lost some steam by day’s end, and the Fed meeting delivered a dose of realism to markets as we head into 2023.
In terms of other data, the November US Empire Manufacturing Index missed expectations, coming in at -11.2 versus +4.5 previously.
Asia Pacific
Similar to the United States and Europe, Asian equities also closed last week lower. Asia-Pacific stocks are now closing in on their worst year since 2008.7
The market’s China reopening bounce appears to have stalled following a huge surge in COVID-19 cases, leading to some questions about the Chinese government’s reopening plan. China’s ambassador to the United States, Qin Gang, said that he believes further measures will be relaxed in the near future, with international travel to the country expected to become easier. However, there were concerns about the current surge in cases, as mandatory testing has now been dropped; meaning, the spread of the virus is difficult to detect and control.
Economic data from China released last week was also poor, with retail sales falling faster than expected and industrial production not as strong as was hoped. Retail sales fell 5.9% year-over-year, while industrial output growth slowed to 2.2%. Also, the country’s housing market continued to slump, with prices falling and sales dropping 31%. Unemployment also rose to its highest level since May.
The week ahead
Unsurprisingly, it looks like an extremely quiet week ahead. No meaningful corporate events are scheduled this week and the macro calendar is also light, with the Eurozone Consumer Confidence reading on Tuesday and UK GDP Thursday the highlights. UK markets are closed half day on Friday.
In the United States, focus will be on consumer confidence data (Wednesday) and GDP (Thursday) as well as Fedspeak.
In Asia, commentary from the last-dove-standing Bank of Japan (BoJ) meeting will be a focus as the market looks for clues on the path into 2023.
Monday, 19 December
Germany IFO Business Climate
Eurozone Construction Output & Labour Costs
Tuesday, 20 December
Germany Producer Price Index
Eurozone ECB Current Account
Eurozone Consumer Confidence
Reserve Bank of Australia minutes
US Housing Starts/Building permits
BoJ policy meeting and interest-rate decision
Wednesday, 21 December
Germany Consumer Confidence
Sweden Consumer & Manufacturing Confidence
Japan Machine Tool Orders
US Existing Home Sales
US Consumer Confidence
Thursday, 22 December
UK GDP & CA Balance
Sweden Retail sales & PPI
Italy Industrial sales
Italy PPI
US GDP
US Week Jobless claims
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1. 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.
2. Source: Bloomberg. There is no assurance that any estimate, forecast or projection will be realised.
3. Source: “ECB hikes rates, sees significant increases ahead as it announces plan to shrink balance sheet,” CNBC. 15 December 2022.
4. Source: Bloomberg. 16 December 2022.
5. Ibid.
6. 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.
7. Source: Bloomberg.