Global equity markets experienced a downturn in the third quarter of 2022, reaching their lowest levels of the year. This was primarily due to concerns over central banks' commitment to combat inflation, even if it hampers economic growth. Bond yields resumed their upward trajectory after a brief pause, with US, UK, and European government bond yields significantly rising since January.
In the UK, the markets faced negative news as the pound hit a record low against the US dollar, and UK government bond yields surged following Chancellor Kwasi Kwarteng's mini-budget. The government introduced substantial tax cuts, estimated at £45 billion, and an energy crisis package of around £150 billion to stimulate a sluggish economy. However, these measures require an additional £72 billion in government borrowing, which has resulted in a rapid depreciation of the currency and increased borrowing costs. Investors seem to be losing confidence in UK government policy.
The fiscal push for growth in the UK is inflationary and diverges from the Bank of England's stance. The BoE is now expected to raise rates faster and to a greater extent than before the mini-budget. Market derivatives anticipate a further 300 basis points increase by the end of 2023, bringing the base rate to 5.5%, a substantial rise from 0.25% at the beginning of 2022. Consequently, the two-year gilt yield reached a 14-year high of 4.5% by the end of August.
In the US, the Federal Reserve implemented two additional 75 basis point increases during the quarter, leading to the highest base rate since 2008 at 3.25%. This represents a 2.25% increase since early June and a 3.0% increase since January. These hikes are substantial, as the last time the Fed delivered a 75 basis point increase was in 1994. Fed Chair Jerome Powell's reaffirmation of the central bank's commitment to raising rates to combat inflation halted the market rally and resulted in a decline in US equities.
Elevated inflation in the US continues to pose challenges to policymakers, despite some positive developments such as the decline in oil prices. The European Central Bank (ECB) also followed suit and raised rates to address inflation, with a 50 basis point increase in July and a subsequent 75 basis point rise in September.
The rise in global bond yields has contributed to significant declines in bond prices throughout the year. However, this new market environment is expected to present more attractive investment opportunities moving forward.
The US dollar reached a 20-year high against a basket of currencies, providing some insulation for UK investors in US stocks against the decline in Wall Street. However, overall returns for UK investors still suffered a negative impact of approximately 7%.
China's renminbi fell to its lowest level since 2008 as the country's central bank implemented easing measures to support economic growth. The divergence in monetary policy with the US put selling pressure on the currency. Despite the falling property market and President Xi Jinping's zero-Covid policies, China's economic growth is projected to lag behind the rest of Asia for the first time since 1990, according to World Bank forecasts.
While second-quarter profits held up relatively well, there is an expectation of a downturn approaching year-end as the effects of monetary tightening become more pronounced. The strength of the US dollar may also hinder overseas earnings. As a result, caution remains prevalent, but opportunities arising from market volatility are still being sought after.