Markets anticipate a Fed pivot

Global equity markets made a strong start to the year as the MSCI All Country World Index gained 7.2% during January. While central banks remain concerned over the elevated levels of inflation, markets appear to be anticipating a more accommodating interest rate environment going forward. Market participants are hopeful that a deceleration in inflation as well as a cool down in consumer spending and labour markets along with the lingering prospect of a recession will give central bankers reason for pause, possibly even a change in direction.

US Federal Reserve officials continue to beat the drum that interest rates need to go higher, possibly at a slower pace, in order to tame soaring levels of inflation. US markets appear to be anticipating that the pace and trajectory of interest rates will not be as severe as the Fed is currently suggesting, with some participants even suggesting a Fed pivot towards a more dovish tone. US bond yields across both the short-term and long-term dipped during the month as the US 2-year and 10-year benchmark yields closed at 4.21% and 3.53% respectively. The longer-term 10-year real yield, which strips out inflation, also fell during January as it closed at 1.28%.

Interest rates and equity prices tend to move in the opposite direction and this was certainly the case during January as the S&P 500 Index returned 6.3%. Equities that are relatively more sensitive to changes in interest rates, such as growth stocks, performed even better with the tech-heavy Nasdaq gaining 10.7%.

In Europe, central bankers appear to be even more committed to increasing interest rates. European Central Bank president (“ECB”) Christine Lagarde has stated that the ECB will “stay the course” with large rate rises on the horizon. As of writing, the ECB increased its benchmark deposit rate by 50 basis points to 2.5%. Despite the ECB’s commitment to tackle inflation through raising rates, inflation in the Eurozone continues to tick lower as December’s inflation declined to 9.2% and as of writing January’s inflation decelerated further to 8.5%. Much of the decline can be ascribed to falling energy costs in the region. The price of Dutch TTF natural gas, the main European benchmark, closed at €57 per megawatt hour, a fall of 25% during the month, which means that since its peak in August of €339 per megawatt hour, the commodity has fallen by more than 80% in less than a year.

European markets appear to be following a similar path to that of the US as the European 10-year benchmark yield also closed lower at the end of January having declined 20 basis points to 2.53%. In turn, European equity markets ended the month higher with gains across major indices such as the Netherland’s AEX (+8.2%), the German DAX (+8.7%) and the French CAC 40 (+9.5%).

Though positive, the UK-based FTSE 100 Index underperformed its international peers, returning 4.3% during the month. Returns for many large cap defensive counters within the healthcare and consumer staples sectors were low to negative. UK inflation has also begun to show signs that it may be decelerating and as of writing, the Bank of England announced another 50-basis point hike but noted that going forward hikes would be economic data dependent as opposed to the “automatic increase” approach it has followed in more recent months.

In Asia, Chinese equities continue to benefit from a relaxation of lockdown restrictions as the “reopening” of the region added a tailwind to the market’s already ebullient view on interest rates. Despite being closed for a week owing to the Lunar New Year holiday period, China’s Shanghai Composite Index climbed 10.5% during the month and Hong Kong’s Hang Seng Index, which includes tech heavy weights such as Alibaba and Tencent, rose in similar fashion.

Many were expecting Japan to pivot from its loose monetary policy following last month’s decision by the Bank of Japan (“BoJ”) to allow 10-year government bond yields to fluctuate to slightly higher levels. However, the BoJ has left its yield curve control measures intact, essentially ensuring that for the time being, interest rates remain low, especially when compared to other regions around the globe. The move by the BoJ sent equities higher but overall returns from Japanese equities during month were slightly more subdued compared to other major markets with the Nikkei 225 Index returning 4.7%.

The local bourse followed a similar path to its international counterparts with the JSE All Share Index returning close to 9% during January.Key contributions came from large cap counters such as Naspers, Prosus and Richemont, benefitting from positive sentiment around China and the impact of less restrictive lockdown conditions. Resource counters were also beneficiaries of Chinese tailwinds with strong gains among diversified miners such as Anglo American and BHP. It was also a strong month for Sasol, returning over 15%, despite the price of Brent crude ending the month at $84 a barrel, only 2% higher than its December close. Gold miners were also lifted higher during the month as the price of the yellow metal gained 6%, breaching the $1,900/ozt level, to eventually close at $1,924/ozt. One cohort that did endure a down January was that of platinum group metals, as the prices of platinum, palladium and rhodium all fell during the month leading to declines in platinum counters.

Crypto “hodlers” have had a tough time of recent following the FTX scandal that led to notable declines in crypto assets such as Bitcoin and Ethereum. However, January has brought a welcomed shift in direction as market sentiment towards digital assets appears rejuvenated leading to sizable gains in Bitcoin (+40%) and Ethereum (+33%).