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Weekly podcast – Market overview
This week, host Fraser Wilkinson, Investment Manager, is joined by Richard Carter, CFA, Head of Fixed Interest Research, to discuss the latest developments shaping global markets.
The pair look at why on the one hand equities have performed well so far this year, while on the other government bond yields have reached levels not seen for decades. Spoiler alert, companies have been growing strongly. Fraser and Richard go on to tackle more brainteasers, such as what new chancellor John Healey can do in the upcoming Budget to boost the UK economy. Richard also runs through technical changes that have taken place in the gilt market in recent years, including changes in both the buyer profile and supply at the long end.
Important information - This is a marketing communication provided for information purposes only and does not constitute independent investment research, investment advice or a personal recommendation.
Market overview
There has been no shortage of potential drivers put forward to explain the relentless rise in global government bond yields seen this year: the US/Iran conflict and resultant surge in energy prices; competitive pressures arising from the huge bond issuance programmes of the artificial intelligence (AI) hyperscalers; high fiscal deficits across the developed world; and more robust than expected economic growth. Other possible drivers such as doubts over the credibility and independence of the Federal Reserve (Fed) have surfaced from time to time but the above four are arguably the ones that have had (and continue to have) the biggest impact.
Taking it in turns
Over the course of the year, each of the four drivers have had their time in the sun. In Q1, the Middle East conflict shifted the interest rate narrative away from possible cuts to likely hikes to counter the inflationary threat. Focus then switched to the AI hyperscaler bond fest and how this was competing against government debt. August’s announcement by the US Treasury that total national debt had reached US$40tn drew attention to the state of the country’s finances. By the end of August, an uptick in hostilities in the Middle East had reignited inflationary fears. And then last week, it was the turn of strong economic data to steal the limelight, specifically well above consensus purchasing managers index (PMI) readings in the US and Europe. These survey-based figures are seen as forward looking and can be viewed as a better representation of where the economy currently is compared to backward-looking “hard” data such as GDP and employment figures.
US running hot?
In the US, S&P Global’s initial estimate for September’s composite PMI, which includes both services and manufacturing output, rose to 58.4. That compares to expectations of 55.3 and August’s 58.0 print (readings above 50 indicate an increase in business activity). If confirmed, September would mark a 62-month high. Growth was all round too with both services and manufacturing contributing. S&P Global now reckons the US economy expanded at an annualised rate of around 4% in Q3. The Atlanta Fed’s GDPNow tracker thinks 4% is on the light side and is forecasting annualised growth of 5.1%. Either way, the US economy is growing at a fair clip.
It’s not just the US
It’s a similar story in Europe. Data released last week suggested the eurozone’s composite PMI for September will come in at 53.1. That compares to expectations of 51.7 and August’s 52.0 reading. An increase in Germany's Ifo Business Climate Index to 89.9 in September from 88.8 in August confirmed the message coming from the PMI numbers. The UK was an outlier, however, after September’s flash composite PMI fell to 51.7 from 52.5 the previous month, although it remains above the critical 50 mark with room to spare.
What FRED says
Growth is accelerating then but what lies behind the view that economic fundamentals rather than inflation expectations are driving bond yields higher at this moment in time? Exhibit#1: US real yields. As nominal bond yields are made up of two components (real yields and inflation expectations), it follows that if one stays relatively stable, then the uptick in nominal yields must be being driven by the other. Real rates can be deduced by looking at the difference between the nominal bond yield and breakeven rates. Over to the charts. As at Friday 25 September, the US 10-year breakeven inflation rate stood at 2.34%, according to FRED (Federal Reserve Economic Data), the Federal Reserve Bank of St Louis’ database. That’s exactly where it was at the start of the week on Monday 21 September—stability personified.
So, with 10-year US Treasury yields soaring to 5.2% from 4.98% over the course of the week, the real yield must account for the difference. This shows up in the numbers. Back to FRED. Rewind to Monday 21 September and the real yield stood at 2.62%. By Friday 25 September real yields had reached 2.85%. Rising real yields suggest strong underlying demand in the economy. And a strong economy leads on to Exhibit#2: Expectations that interest rates hikes will be needed to cool down a potentially overheating economy. Hey presto, expectations for US interest rates have risen too.
At the beginning of September and before the Fed raised rates by 25 basis points at its policy meeting on 15/16 September, around 0.6 percentage points of rate rises had been priced in over the next 12 months. By the end of September, and following the strong economic data, futures markets are now pencilling 0.9 percentage points of rate hikes over the next year.
Rising real yields and interest rate expectations are two reasons why strong economic fundamentals appear to be driving global bond yields higher. There is also a third reason. Exhibit#3: Rising stock markets. For despite a percentage point increase in the 10-year US Treasury yield since the turn of the year, equities have continued to make good progress. And because of this, the world according to FRED appears to have legs.
Weekly market moves:
The MSCI All Country World Index (MSCI ACWI) ended the week 1% higher (+14.7% YTD).
United States:
Once again, US stocks outperformed courtesy of a 1.2% gain for the week (+14.1% YTD). Technology stocks led the way buoyed by strong uptake of Meta’s latest AI release, Muse. No surprise then that growth (+2.4%) outpaced value (0.0%) over the course of the week. Slowly but surely, growth (+7.2%) is eating into value’s (+21.2%) YTD lead. Question is, will there be enough time for growth to overtake value before the end of the year? As for small caps, a weekly loss of 0.8% trimmed the YTD gain to a still respectable +15.5%.
As mentioned earlier, not a good week for US Treasuries. The yield on the 10-year Treasury rose 16 basis points to 5.16% (up 99 basis points YTD). The 5.00% level has represented something of a ceiling for 10-year Treasury yields in recent years but last week the market broke, and closed, decisively above this level for the first time since 2007. The 2-year Treasury yield ended up 10 basis points to 4.85% (up 138 basis points YTD).
United Kingdom:
UK equities couldn’t match the pace set by the US but still ended the week in positive territory— both large and mid-caps posted a weekly gain of 0.3%. YTD, the mid-caps just have it, up 10.7% compared to the large caps’ 10.4%. Sterling lost ground, finishing the week at US$1.32 compared to US$1.34 previously. That higher-for-longer interest rate narrative in the US showing up in forex markets? Still, UK gilts couldn’t resist the global pull of higher yields: the 10-year gilt yield closed up eight basis points at 5.37% (up 89 basis points YTD).
Europe ex UK:
The MSCI Europe ex-UK Index posted a weekly gain of 0.8% (+9.8% YTD). At the national level, Switzerland’s main market fared the best with a 1.2% weekly gain (+8.4% YTD) followed by Italy’s which ended up 0.7% (+19.0% YTD). Germany tacked on 0.4% (+3.7% YTD) and France 0.3% (+1.9% YTD). Like sterling, the euro lost ground, ending the week at US$1.14 compared to US$1.15 previously, with the move also likely explained by interest rate differentials. The 10-year German bund yield matched the 10-year gilt’s eight basis point weekly rise (up 75 basis points YTD).
Important information
Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest.
This material is a marketing communication provided for information purposes only and does not constitute independent investment research. References to financial instruments are for general information purposes and are not subject to requirements applicable to independent investment research.
Any references to securities or financial instruments should not be regarded as a personal recommendation, or as an offer, solicitation or invitation to buy or sell any financial instruments. The views expressed are those of the authors at the time of publication and are subject to change.
This material does not constitute tax, legal or accounting advice. You should seek independent professional advice appropriate to your individual circumstances before making any financial decision or engaging in any transaction.
Author
Fraser Wilkinson
Executive Director
Richard Carter
Head of Fixed Interest ResearchTo listen to all the past Weekly Comment podcasts click here or subscribe via the apps below:
