July signified a propitious epoch for numerous stock markets, albeit international returns for investors in the UK were slightly offset due to an additional appreciation of sterling, with the GBP/USD exchange rate soaring to a zenith not witnessed in over a year. Recent communications from central banks, post monetary policy congregations in London, Frankfurt, and Washington, have insinuated a looming cessation to the cycle of elevating interest rates trans-Atlantic, thus diminishing market-implied prognostications for terminal rates.
US stocks documented a return close to 3% in local currency terms during July, prolonging their sequential monthly victories to five, which is the most extended sequence since summer 2021. A marginal ascent of slightly over 1% in the GBP/USD rate slightly attenuated returns for UK investors, yet it still signals another robust monthly progression.
Headlines have been dominated by the US fiscal stance following Fitch Ratings' decision to downgrade the US debt rating, a mere few months after the brink of a default on its debt, triggered by political machinations. Both current and former US Treasury Secretaries, Janet Yellen and Lawrence Summers respectively, criticized the decision, which although unforeseen, had a circumscribed effect on the market. Presently, while we don't perceive this as a substantial market development, we maintain a watchful and cautious perspective for indications of altered and potentially impactful situations.
UK stocks managed a slight outperformance in July, registering gains of 2.6% versus the MSCI All Country World Index's 2.5% return in sterling terms. Despite a year-to-date narrow trading span and closing July approximately 1% lower for the year, the UK has encountered challenges due to an unanticipated non-resurgence in activity following China's reopening and the amplifying pound.
Recently, the UK government bond curve has experienced a subtle shift with short-dated gilt yields declining amidst anticipations of a subdued pinnacle in interest rates, while longer-dated gilt yields have marginally ascended. Comparable motions have been observed in European and US government bond markets, as the belief in a potential for a "soft landing" amplifies and/or predictions of inflation—although poised to recede shortly—will linger more persistently mid-term than formerly anticipated.
July's optimum equity returns were witnessed from MSCI Emerging Markets and MSCI All Country Asia Pacific ex Japan, which escalated 5.0% and 4.6% respectively. Europe ex UK slightly lagged, ascending 1.8% as augmented signals of economic fragility in the bloc amplified apprehensions regarding future economic activity levels.
The Bank of England (BoE), whilst eventually sanctioning a 25 basis point augmentation in its base rate, did entertain speculations of a more substantial 50 basis point enhancement, owing to comparatively dismal inflation dynamics in the UK. Ultimately, the Monetary Policy Committee was divided, with a majority of six members deciding upon the 25 basis point move. This caused a minor dip in market expectations for the BOE's terminal rate to approximately 5.60%, ascending from the current 5.25%.
With the BoE, European Central Bank, and Federal Reserve on course to conclude their tightening cycles in upcoming months, the Bank of Japan (BoJ) might be in the initial phases, presenting the most definitive indication yet of its departure from nearly zero interest rates. The BoJ, in its July convening, retained the overnight rate at -0.1% but disclosed a potentially impactful alteration in its yield curve control policy, elevating the cap on 10-year government bond yields to 1.0% from 0.5%.
Persisting with an exceedingly loose monetary policy during the last 18 months, whilst the majority of other developed nations have incrementally heightened interest rates, Japan has propelled a potent advancement in the Tokyo stock market and a significant depreciation in the Yen. If the BoJ initiates rate hikes, these trends, especially in the currency, could swiftly retract.
In a nutshell, despite the global GDP growth and labor markets maintaining better-than-anticipated performance, numerous market cycle indicators convey unfavorable signals, including new orders, purchasing managers indices, and senior lending figures. Inflation is evidently moderating, albeit core metrics could prove more intransigent. UK, Eurozone, and US central banks seem to be approaching the culmination of their vigorous tightening cycles, even as their respective economies are demonstrating resilience beyond expectations. Prominent risks encompass overly aggressive policy tightening potentially triggering severe recessions, additional bank collapses, and a credit squeeze, while geopolitical dimensions also linger notably, embracing not only the Russia/Ukraine conflict but also discord between China and the West.
Acknowledging the intrinsic delay with which the monetary policy transition mechanism operates, the effects of current rates might necessitate time to permeate. Proximate reductions in interest rates have become increasingly improbable, as "soft landing" odds have burgeoned. Equity markets, excluding the UK, are robustly ascendant for the year, although a dash of complacency surrounding earnings might be present. Second-quarter figures have largely transpired uneventfully against modest expectations, with earnings down over 5% year-on-year.
The typically lean markets in August often usher in volatility. Our stance remains cautiously measured, acknowledging that a deceleration is imminent, yet without substantial indications regarding its depth as yet. We advocate for a pragmatic strategy, punctuated with routine modulations to regional and sectorial exposures, where remaining adaptive is pivotal, e.g., with the technology sector emerging as the top performer year-to-date after being among the primary stragglers in 2022. A diversification of leadership in the upcoming months, given the exceedingly narrow market breadth in 2023, would be desirable.