Macro and Markets Review for August 2024
Gary Dugan, Chadi Farah, Bill O'Neill
The Global CIO Office
The month’s feature was the massive spike in market volatility after the Bank of Japan surprised the market by increasing interest rates, and worse than expected US employment data led to fears of a US recession. The rise in BoJ rates led to a significant closing off of the so-called Yen carry trade, where investors shorted (borrowed) Yen and bought the dollar. Markets went through some crazy volatility, best referenced by S&P500 equity market volatility, measure the Vix index, which rose to 38, a level not seen since the COVID crisis.
The good news was that the ‘crisis’ subsided within a few days. In the event, the Bank of Japan’s action in increasing interest rates has proven right and logical, with further signs that the economy is improving. And subsequent data showed that the US economy was far from being on the cusp of a recession.
Chart 1: Massive Spike in Equity Market Volatility
VIX Index
Source: Bloomberg
The global growth surprises for the major economies spent much of the month in negative territory. The slide in the United States was initially of concern, and investors feared an increase in recession risk. However, as the month closed out, US growth appeared on a better footing, and inflation in Europe and the United States seemed to be moderating faster than the central bankers had expected. Japan’s improving ability to create inflation supported investor confidence in the Japanese asset markets after the early-month volatility.
Chart 2: Global Economic Growth Surprise Indices – Japan leads the recovery
Index
Source: Bloomberg
The moderation of growth and the downside surprises in inflation led to greater investor confidence that central bankers would follow through and deliver timely cuts in interest rates. At this juncture, the most likely outcome is a 25bps cut in interest rates by both the Fed and the ECB at their meetings in September, with an outside chance of a 50bps cut by the Fed.
The ECB cut rates by 25bps in June. The UK MPC and the New Zealand central bank surprised the market by cutting interest rates by 25bps in the first half of August.
Chart 3: The Fed is likely to cut rates in September – It has been a long wait
Fed funds rate (%)
Source: Bloomberg
In the emerging markets, there is a continuing contrast between the good news coming out of India and the disappointing economic data flowing from China. However, there are some tentative signs of improvement in China, backed by ongoing government efforts to stabilise the real estate market and boost consumer confidence.
At the end of July, President Xi Jinping acknowledged that the “focus of economic policies should shift more towards benefiting the people and promoting consumption”. Through August, we have had a drip feed of government initiatives mainly focussed on real estate. For instance, many cities have withdrawn price controls over new residential properties. The state-owned enterprises (SOE) stand ready to buy out unsold housing inventories at cash-stripped developers.
Chart 4: China’s CAIXIN Manufacturing Sector Confidence Index Drops Away
Source: Bloomberg
Markets
Equities
European equities outperformed US dollar returns for the month, making up some of the year’s underperformance. US equities continued to provide more consistent returns. In August, there was a shift in the US from the tech sector to the old economy sectors as tech sector earnings reports were not as strong as expected.
Table 1: Equity Market returns in August
Source: Bloomberg, MSCI
Japanese equities finished the month with a 0.5% increase in dollar terms, but it was a very volatile month. In local currency, the index had a -2.7% return, however, at one point dropping 21% from the level at the beginning of July.
Chart 5: Remarkable collapse and rebound in Japanese equity market
MSCI Japan net total return index in local currency
Source: Bloomberg
In general, emerging markets were relatively quiet, but the ongoing recovery of the Brazilian stock market stood out. The Brazilian economy has recently experienced accelerated growth due to stronger consumer spending, which in turn is supported by solid wage growth. Although interest rates remain high at 10%, the market expects the central bank to have the opportunity to reduce them to 9% by the end of the year. Inflation remains at around 3%.
Equity sector performance
The tech sector struggled to be the sharp outperformer seen earlier in the year. Instead, more of the old economy stocks provided the leadership as investors speculated about how far and quickly the Federal Reserve could cut interest rates through the balance of the year. Consumer discretionary stocks at a global level failed to perform. However, as the month closed in the US, consumer discretionary stocks stood out on the back of higher-than-expected Q2 GDP growth led by the consumer.
Table 2 : Global equity sector returns in August
Source: Bloomberg
Bond markets
As investor confidence has continued to build, inflation is falling slightly quicker than previously thought, allowing yields to drift down. As the month developed, the gap between the US 10-year and 2-year bond yield closed, and the market discounted a speedy and consistent drop in the Fed Funds rate. At the start of August, there were investor concerns about a US recession, and hence, the US high yield underperformed. Subsequently, better-than-expected growth data and lower-than-expected inflation helped the recovery of the high-yield bond index.
Chart 6: US 10-year and 2-year government bond yields converge as Fed rate cuts anticipated
Table 3: Bond market returns In August
Source: Bloomberg
FX and Precious metals
Aside from the volatility of the Yen the main feature of the currency market was the persistent weakness of the dollar that lost value on a broad front. Conversely, and as to be expected gold rallied to a new high of $2524
Table 4: Monthly performance of precious metals and currencies for August
Source: Bloomberg
SDAX Investment Deals
