Interest rates are going to stay higher for longer. That is the view of global equity markets and accounts for the broad-based weakness in stock prices, the declines of which resulted in the MSCI ACWI falling 3.4% during the third quarter of 2023.
As a rule of thumb, stock prices and interest rates tend to move in opposite directions. It therefore follows that if interest rates are not expected to come down, at least not at the rate that the market expects, stocks will reprice, in this case fall, to adjust to the new set of expectations.
For months now, the market had eagerly anticipated that central banks would announce an end to the trend of hiking interest rates. In particular, many were hopeful that the US Federal Reserve (“Fed”) would announce, at worst, one final rate hike followed by a series of interest rate cuts during the course of 2024. This was not to be the case. While inflation has come down significantly since the commencement of the rate hiking cycle, it still remains elevated. The “stickiness” proved apparent in the August read of CPI which increased slightly to 3.7%, still well above the Fed’s target rate of 2.0%.
This likely reinforced the view of the Fed to maintain a higher level of interest rates. The Fed may have opted to hold interest rates constant following the FOMC meeting in September, but Fed chair Jay Powell noted that the majority of Fed officials favoured an additional rate hike later this year. Perhaps the most disappointing piece of news emanating from the meeting was the consensus among participants that interest rate cuts might only start taking place at the back-end of 2024, somewhat later than what the market may have been pinning its hopes upon.
Movements in bond yields certainly echoed the view of “higher for longer”. The yield on the benchmark 10-year US Treasury rose nearly 20 basis points during the quarter to end the period slightly above 5.0%. Perhaps more impactful, especially for longer duration equities has been the rise in the “real” rate of interest (see discussion further below for more detail). The 10-year US Real yield (US Treasury constant maturity or “TIPS”) rose more than 60 basis points during the quarter, closing out the period at 2.2%.
Higher interest rates were not the only detractor during the quarter. The post-covid recovery, or lack thereof, in China remains a burden on Chinese equities as well as those companies with relatively larger exposures to the region. Concerns over slowing economic growth and the highly indebted property sector, continue to weigh on investors’ minds as Western assets poured out of the region.
The downturn during the quarter was generally broad-based, be it sectoral or regional. There was however one notable exception, the Energy sector. The price of oil rose nearly 30% over the past three months, leading many oil companies, be they upstream or downstream to double-digit price gains during the period. Production cuts by Saudi Arabia and Russia drove the price of Brent Crude as high as $95 a barrel. Some speculators have even suggested that it may rise above $100. At this level, inflation may prove even stickier than it is already proving to be. Could we move to an environment of higher for even longer?
On the flipside, with interest rates now back at levels last seen during the Global Financial Crisis (“GFC”) of 2007/8, the question will be asked, how long can these levels be sustained before something breaks? US consumers appear to have used up much of their pandemic savings and are increasingly resorting to using their credit cards. Credit card delinquencies have in turn begun to rise, rising to 2019 levels, but still well below what was experienced during the GFC. Delinquencies is other areas such as the auto market have also been on the rise.
Regardless, the US dollar is benefitting from expectations around “higher for longer”. The US Dollar Index, a measure of the of the US Dollar against a basket of other currencies gained over 3.0% during the quarter. In contrast, gold, which does not typically enjoy an environment of higher interest rates owing to higher holding costs, dropped below $1,900/ozt to end the period at $1,871/ozt.
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