Equity markets have remained choppy in the face of rising uncertainty: there are worries over Chinese and global growth, bond yields are rising and the monetary policies of the main central banks appear to be shifting. Yet financial markets do not seem to be overly nervous and investors appear willing to favour good news or, at least, they are not ignoring it.
Global equities lost a sizeable 3.7% (29 September close of the MSCI AC World index) from the end of August) as 10-year bond yields rose by around 20bp in the US and the eurozone. Crude oil prices were up by 9% to USD 75 for a barrel of WTI and the US dollar gained 1.8% (DXY index).
The last few days of September saw a stabilisation after the sharp moves. Implied volatility on the S&P 500 equity index had hit its highest level since May on 20 September before ebbing.
Recent events appear to have left investors bewildered, but they have not panicked. Bewildered because the return to a more normal life after the pandemic is taking longer than expected. They have remained confident in the outlook because, for now, it is insufficient supply rather than insufficient demand that is the issue.
As for the growth outlook, events in China are being watched particularly closely. Purchasing Manager Index (PMI) surveys of purchasing managers have diverged. The PMI for the manufacturing sector fell to below 50 in September – its sixth consecutive decline – and is pointing to slower growth.
On the other hand, the services index rebounded strongly from 47.5 to 53.2, driven by accelerating demand for transport and restaurants.
The debt-related difficulties in the property sector could pose a risk to domestic demand, leaving many observers to expect the imminent announcement of government support measures. Beijing has room to manoeuvre and could use it in the short run to prevent any spill-over to the financial markets. Structural programmes should take longer to be decided and implemented.
Across the globe, the lifting of Covid-related restrictions is making it easier for activity in the services sector to resume. This should continue as the pandemic ebbs. Globally, the number of new daily infections has dropped from around 660 000 at the end of August to 450 000 at the end of September. However, the seasonality of the virus and the return of pupils and students to school in many countries are still likely to trigger another outbreak, which would then weigh on household confidence.
Bottlenecks in the manufacturing sector are persisting, not least because production was disrupted this summer when emerging Asian countries were hit hard by the Delta variant. Rising commodity prices are also likely to weigh on industrial activity, especially in energy-intensive sectors. As a result, upward price pressures are persisting too, putting the thesis of a temporary acceleration in inflation to the test.
Early estimates of eurozone consumer price indices are pointing to a continued rise in inflation. At 4.0%, inflation in Spain surprised to the upside. In France, it was slightly lower than expected at 2.1%.
While officially the main central banks are sticking to the messages that they have been broadcasting, the interpretation of their views has shifted.
In the US, at the Federal Reserve, Chair Jay Powell communicated his intentions on 22 September. However, in the days that followed, it appeared that the policymaking FOMC committee was divided not only over the date of the first rate increase, but also, more fundamentally, over the interpretation of the Fed’s flexible average inflation targeting framework.
Some FOMC members believe that key rates can remain low (at around 1% in 2024) with inflation slightly above 2.0%, while others, such as Fed Vice-President Richard Clarida, believe that much progress along the path towards the longer-run rate will have been made by 2024.
These divergent views could partly explain the upward pressure on US long-term bond yields since the latest FOMC meeting and the renewed expectation in the markets that key interest rates may be rising in the foreseeable future.
In the eurozone, recent weeks have been marked by statements from several ECB members who want to distance themselves from the inflation forecasts released in September. They consider these to be too low. Their comments have fuelled the suggestion that the mood may soon become more hawkish at the ECB.
At the ECB Economic Forum, President Christine Lagarde and Fed Chair Powell reiterated the view that the recent acceleration of inflation should be seen as transitory.
However, other monetary institutions are taking a different view: The Reserve Bank of Norway has raised its policy rate from 0% to 0.25% and indicated that more can be expected in December. It specified that the rate should be raised to 1.25% by the end of 2022. The Bank of England, for its part, has signalled that recent developments are reinforcing the need for a ‘medium-term ‘rate rise.
In the last quarter of 2021, we can expect investors to start saying farewell to an ‘extraordinary period’ that required ‘extraordinary measures’, to use Christine Lagarde’s words in March 2020.
The normalisation of monetary policies will likely be prudent, gradual and conducted in the spirit of avoiding any sudden moves on financial markets. Details on the outlook are expected ahead of December’s policy committee meetings.
After having spent months in intensive care, economies will have to begin, or continue, their recovery and rehabilitation under less ‘extraordinary’ financial conditions. It should work, as long as they’re healthy… and supported by fiscal policy.
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