Market gyrations stoke recession worries
After a good first half of the year equity markets hit the buffers last Monday. Global markets fell, volatility surged, and investors stampeded into safe assets, including US treasuries. At one-point, global equities were down 8% from their July peak. The sell off was most acute in Japan, where the main index suffered the sharpest one-day decline for 37 years last Monday. Investors also focused on the US, with the S&P 500 having its worst day since 2022.
- Since then, markets have regained most of those losses and volatility has fallen back. Most major stock markets are still up comfortably year-to-date. As the dust settles the big question is whether last week’s market ructions were a harbinger of weaker growth. Several reasons have been given for the sell-off.
- Firstly, tech stocks, and semiconductor makers more specifically, have fallen in recent weeks as investors reassess prospects for gen-AI. Chipmakers ASML and Nvidia are down more than 20% from their July peaks (though are still up 618% and 58% respectively since the start of 2023). Intel, a US chipmaker, has suffered a collapse in its stock at the start of the month after announcing a turnaround plan including 15,000 job cuts. Its equity valuation is now just over half of its July peak.
- Second, the Bank of Japan surprised markets by raising interest rates for only the second in 17 years, taking Japanese rates to highest level since 2008. The yen rallied in response, creating a new headwind for Japanese exporters. These companies have powered the revival in the Japanese equity values in the last two years. Fears that a strong yen would hamper exports contributed to last week’s sell-off in Japanese stocks.
- The BoJ’s action also triggered selling pressure in other countries’ equity markets, driving stock prices lower, as investors partially unwound so-called carry trades, where money is borrowed in currencies where rates are relatively low (in this case Japanese yen) and invested in higher yielding assets in countries with higher rates.
- Third, compounding these technical issues, weak economic data in the US stoked investor fears about a possible recession in the world’s largest economy. There have been signs the US economy is slowing and markets appeared to take exception to the weaker-than-expected jobs numbers released at the start of this month and survey data showing a softening in US manufacturing activity.
- The rise in US unemployment triggered the so-called ‘Sahm rule’. Research by US economist Claudia Sahm shows that, in the past, when the three-month average unemployment rate exceeds the lowest rate of the last 12 months, a recession had begun. The ‘rule’ is not an exact science, and the recent rise in US unemployment has been slower than ahead of previous recessions. Dr. Sahm herself said that her rule may be giving a false positive due to the unusual conditions that have followed the pandemic.
- An additional concern is that consumption, which has driven America’s recovery, is weakening. Rising unemployment, the depletion of pandemic-era savings and a rise in delinquencies on credit card payments for poorer households suggest higher interest rates are squeezing demand. The University of Michigan’s consumer sentiment index fell to an eight-month low in July and many consumer-facing businesses have reported disappointing earnings, including fast food giant McDonald’s, delivery firm UPS and domestic appliance maker Whirlpool.
- However, these developments seem consistent with a widely expected slowdown in US growth rather than an imminent recession. Investment bank Goldman Sachs has increased the probability it assigns to the US going into recession in the next 12 months, but only to a one-in-four chance. The economy is still adding jobs, albeit at a slower pace, and although the unemployment rate has ticked up, it remains at low levels. Other macro data are more positive. Last week a separate labour market release showed claims for unemployment insurance declined. Though backward-looking, GDP growth accelerated to an above-trend 2.8% on an annualised basis in the second quarter, and last week PMI data indicated continued robust expansion of the services sector in July.
- Prior to the weak jobs report the US Federal Reserve held rates unchanged at their highest level since before the financial crisis. The decision was expected by traders but the subsequent soft jobs data increased anxiety that the Fed should have cut rates. Markets are now pricing in four or five quarter-point reductions by the end of the year, a sharp increase in the pace of easing expected just a week ago.
- If the Fed does cut rates as expected, it should have a supportive effect on markets and the real economy. On the other hand, if the Fed feels the need to keep rates higher for longer to quell inflation, market volatility may return, which could hit business confidence and tighten credit conditions, weighing further on growth.
- Equity market moves are rarely an accurate predictor of changes in the economic outlook, but last week’s increase in volatility, which has been strangely absent so far in this tightening cycle, is a reminder about the risks to growth. For now, the data seem consistent with a slowdown in the US not a recession. Still, a soft landing is not in the bag. A Fed assessment of previous US economic cycles finds that, “soft landings, in which inflation is contained without inducing a recession, are rare but not unprecedented”. We must hope for just such a rare but not unprecedented outcome this time round.
OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.1% at 8,168.
Economics
- Markets around the world sold off early last week, causing the VIX measure of volatility, often referred to as Wall Street’s fear gauge, to rise to its highest level since October 2020
- Factors thought to have contributed to the sell-off included the preceding week’s disappointing US jobs data heightening fears of a US recession, the Bank of Japan’s surprise decision to raise interest rates and the Fed’s decision to keep rates on hold the previous week. In addition, a revaluation of the potential of AI, concerns that some tech stocks were overvalued and thin liquidity during the summer holiday season are thought to have perhaps played a role
- Later in the week markets recovered much of their lost ground following several developments
- The Bank of Japan ruled out a further rise in interest rates while markets were volatile
- The Institute for Supply Management’s measure of activity in the US service sector returned to growth in July, helping to assuage concerns over an imminent US recession
- A fall in new unemployment claims in the US further assuaged investors’ fears of a deterioration in the US labour market
- Chinese ten-year sovereign bond yields fell to a record low of 2.12% last week amid worries over the health of the Chinese economy before rising on the news that consumer price inflation unexpectedly picked up to 0.5% in the 12 months to July
- Shipping giant Maersk said that retailers and manufacturers were pulling forward orders from China as they aim to avoid possible disruption to supply chains should US-China relations deteriorate later in the year. The development may distort economic data, particularly inventories
- Chinese exports in July were weaker than anticipated but imports rose by 7.2% compared to the same month last year, in part due to a 24% spike in imports from the US, which may also reflect concerns over trade restrictions
- The UK Office for National Statistics issued new estimates for UK growth in 2022. It now thinks the economy grew by 4.8% as it recovered from the pandemic, up from 4.3%
- The number of applications for a UK visa to work in health and social care dropped by 82% in July compared with the same month the previous year following a change to the rules that barred applicants from bringing dependents
- UK house prices rose by 0.8% from June to July according to estimates from Halifax as mortgage rates have begun to decline
- UK chancellor Rachel Reeves met with large Canadian pension funds and said she wanted the UK to follow their example of fewer, larger funds that invest more in infrastructure and equities
- German industrial production partially rebounded in June, rising 1.4% following a fall of 3.1% the previous month. Industrial orders rose by 3.9% in the same month, the first month-on-month rise this year
- Euro area retail sales fell by 0.3% from May to June driven by a fall in sales of food, drink and tobacco
Business
- UK stockbroker Hargreaves Lansdown agreed a £5.4bn takeover by a consortium of private equity firms
- Microsoft warned that Iran-backed group were increasingly launching cyber-attacks and disinformation campaigns in the run-up to US presidential elections
- Rheinmetall, Germany’s largest arms maker, announced a significant increase in sales, profits and orders amid wars in Ukraine and the Middle East
- Barclays told its UK staff that it would the scrap the EU bonus cap for some senior staff, allowing bonuses up to ten times base pay, following the UK’s post-Brexit decision to remove the restriction, the FT reports
- British Airways announced it would cease flights from London to Beijing as a ban on overflying Russia increased the length and complexity of the route
- Two candidates to chair the UK parliament’s science, innovation and technology committee said they would summon X (formerly Twitter) CEO Elon Musk to examine the role of the platform in recent UK public disorder
Global and political developments
- Ukrainian forces advanced over six miles into the Kursk region of Russian in the largest counteroffensive on Russian soil in the war so far
- Organisers cancelled three sold-out Taylor Swift concerts in Vienna following the arrest of a 19-year-old man who confessed to planning to attack the concert
- UK prime minister Keir Starmer told rioters that they would face the “full force of the law” following scenes of significant unrest at far-right protests across the UK
- Labour politician Eluned Morgan was voted in as the new Welsh first minister, the first woman to hold the office
- Bangladesh’s parliament was dissolved after prime minister Sheikh Hasina resigned and fled to India. Micro-lending pioneer Muhammad Yunus was appointed as a de facto interim leader and appealed for calm following violent scenes
- US vice president and Democratic presidential nominee Kamala Harris announced Minnesota governor Tim Walz as her running mate
- At the time of writing, some bookmakers had Ms Harris as a narrow favourite to win the November elections, a significant shift – as recently as mid-July bookmakers’ odds implied a two in three chance of a Trump victory
- Acting Iranian foreign minister Baqeri Ali Bagheri Kani said that Iran had “no choice” but to respond to Israel’s assassination of Hamas political leader Ismail Haniyeh in Tehran the previous week but that it would be "at the right time and in the appropriate shape"
And finally… a family holiday to Disneyland was ruined when the UK Passport Office rejected the application for six-year-old Khaleesi Holloway claiming it would infringe the trademark of the Game of Thrones character that she was named after. The decision was overturned following an appeal, but the decision came too late for the original dates that the Holloway family wished to travel – Deny-rys Targaryen