Markets Wrap (12–26 September)
The S&P 500 fell to the lowest level since December 2020, as markets were rattled by the UK government's plan to employ fiscal stimulus, which is a dangerous combination along with record inflation.
Amid mounting recession fears, defensive stocks trade at multi-year highs versus the rest of the market – one would have to pay around 75% premium in terms of the P/E ratio for an average European listed company in either food and beverages or household and personal goods sectors (Chart 1), as valuations are very close to levels seen during the global financial crisis.
US 2y Treasury yield climbed to the highest level since 2007, whereas the 2y/10y spread fell to a new low of close to -50 bps, as the market continues to price-in an increasingly hawkish FED, followed by a recession due to the steep tightening of the monetary policy (Chart 2).
The Riksbank delivered a full percentage point interest rate hike at its 20 September meeting; even though the move was 25 bps above the consensus estimate, EUR/SEK trended higher following the meeting, as the interest rate path was raised less than the market expected – it currently projects 50 bps higher interest rates in November and another 25 bps uptick in February 2023 (Chart 3).
The FED hiked by another 75 bps (to 3-3.25%), the updated dot plot now implies an additional 125 bps increase by the end of the year, and higher than the 2.5% neutral level interest rates are to be expected until 2025 (Chart 5).
Norges Bank, as expected, raised the base rate by 50 bps, to 2.25%; whereas the short end of the interest rate path was lifted only marginally, and for the period following 2024 it was even lowered (Chart 4); the Monetary Policy Committee noted that tightening is starting to have an effect on the Norwegian economy, which is another hint that the key rate may soon peak.
The Bank of England did not surprise the market by raising the base rate by 50 bps for the third time in a row (to 2.25%), and as expected, announced its plans to shrink the balance sheet by GBP 80 billion every month over the coming year.
The Bank of Japan remains an exception among the world’s central banks, as its key interest rate remains untouched at -0.1%; so far in 2022 the JPY has lost over 20% versus the USD – the most among the G10 group of currencies.
The GBP fell to the lowest level ever versus the USD (GBP/USD 1.079 at the time of writing) after markets were spooked by the UK's new Chancellor of the Exchequer K. Kwarteng's remarks that planned tax cuts worth 45 billion pounds is only part of a wider fiscal stimulus package – a move that would almost certainly exacerbate the problem of rampant inflation.