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After a strong start to the year for most asset classes in January, February saw a retracement of many equity regions and bond markets, in local terms. However, with the weakness in sterling versus the dollar over the month, the picture was more favourable for sterling investors. The main driver was that economic data was more resilient over the month than expected, meaning any hoped-for pause in interest rate rises may be some way off. Over the month we saw interest rate rises in the US, Europe and the UK, leading to negative returns for all parts of the bond market universe.

UK and European equities were the best performing of the equity regions in February, delivering over +2% returns. In the UK, large cap companies were among the top contributors and the FTSE 100 index achieved a new record high. Also domestically focused areas of the market outperformed, as the UK economy proved more resilient than was expected. The latest GDP data revealed that the UK economy had not contracted in the fourth quarter of last year. This meant the economy dodged a technical recession by avoiding consecutive quarters of decline following the contraction in the third quarter. The Bank of England in its latest quarterly forecast, said it expected the UK to fall into recession later in 2023, however, the downturn appears to be much shallower than it had previously forecast. This in part has been driven by energy prices falling considerably.

It was a similar story in Europe, where forward looking data painted an encouraging picture for the eurozone economy. The Purchasing Managers Index (PMI) increased from 50.3 in January to 52.3 in February. A reading above 50 indicates economic expansion. Financials, industrials & telecoms were the best performing sectors over the month.

Asia & the emerging markets were the worst performing equity regions, delivering over -4% return for the month in sterling terms. This was a partial reversal of the strong returns we saw in January and was partly due to escalating geopolitical tensions between China and the US, while more resilient macro data out of the US raised the prospect of further rate hikes. Against this backdrop we saw the dollar rally, proving an headwind for Asia and the emerging markets.

Whilst returns were somewhat mixed for equity investors, there was no hiding place for fixed income investors. Global government bonds, investment grade and high yield all sold-off. With the rate hikes we saw across the US, Europe and UK, the markets concluded that interest rates would likely need to remain higher for longer. This was supported by strong macro data and PMI’s across the different regions. We saw sharp increases in yields in government debt – the US 10-Year yields increased from 3.51% to 3.92%, while the UK 10-Year moved from 3.34% to 3.71% and from 2.29% to 2.65% for German 10-Year. February saw a reversal of the strong returns that January brought for the bond markets.

All major equity markets posted negative returns in December as investors began to price in the risks of impending recession. The strongest declines were seen in developed markets (MSCI World Index fell 4.2%) while emerging markets were relatively resilient (MSCI Emerging Market Index fell 1.5%). Emerging markets were supported by Chinese equities which rallied in December on the back of lifting of restrictions related to COVID-19.

Government bonds also posted negative returns during the final month of the year. As expected, the European Central Bank delivered a 0.5% hike. However, a surprisingly hawkish statement, and forecasts triggered a sell-off across Eurozone markets. In the US, a lower-than-expected November CPI print didn’t significantly move the market. As anticipated, the Federal Reserve hiked rates by 0.50% during the month, although forecasts for the peak rate increased marginally. This drove US Treasury yields higher, particularly at the longer end of the curve. In the UK, gilts recorded poor performance even as the Bank of England moved in a more dovish direction. The Bank of England met market expectations with a 0.50% rate hike, and confirmed that they believed UK inflation had peaked. The Bank of Japan surprised markets as it moved to relax its Yield Curve Control policy, resulting in notable falls in Japanese bond markets.

We saw some dollar weakness during December, triggered primarily by the lower than expected US CPI print. The Euro was the second strongest performer in the G10 in December, in part benefitting from a still hawkish ECB. Sterling traded largely sideways against the USD amidst ongoing signs of poor economic performance and a still dovish Bank of England.

Oil prices fell during December, as markets continued to discount the commodity on expectations of slowing growth in 2023. This was despite OPEC+ reaffirming its commitment to its current oil production cuts of 2m barrels per day until the end of 2023.

Headline inflation rates have begun to cool, and we expect to see the end of hyper-aggressive monetary tightening. We forecast another 0.5%-1.00% of Federal Reserve rate hikes in the first quarter of 2023. This may reverse later in 2023 if the economy tips into significant recession. We expect targeted fiscal policy support, which will help limit the depth and duration of any cyclical downturn e.g. limiting the effects of the energy shock in Europe.

Currently we are expecting a US recession in 2023. Household spending held up well last year, but savings rates now sit near record lows, and the labour market may be cooling.  In the Eurozone, recession also looks likely with some activity indictors consistent with contraction. Sufficient levels of gas storage have helped limit the impact of the energy shock to activity but this will be tested as we progress deeper into winter.

Global Equities delivered a second consecutive month of positive returns in November; erasing more of the falls experienced earlier in the year. The November rally was led by the Emerging Markets, with Chinese equity delivering particularly strong returns. The positive returns have been driven by signs that bond yields might be peaking, and favourable announcements made by the authorities in mainland China, such as relaxation of a COVID-19 related restrictions and support package for the property sector.

November brought a wave of cautious optimism in developed bond markets on the back of a US CPI undershoot and more dovish Fed commentary. The Fed and The Bank of England both increased rates by 0.75% over the month. UK bond markets were supported by the fiscal consolidation set out in the Autumn statement, bleak OBR forecasts and economic indicators such as PMI pointing towards an economic contraction. Eurozone yields also fell over the month, and German-Italian spreads narrowed as the market became less cautious on risk.

In emerging market debt, China was the big story, with the market anticipating a potential re-opening. This led to a “risk on” move, causing bonds to sell off. Poland was another big mover, with some central bank members indicating that an economic slowdown and tighter money supply could allow for potential rate cuts.

Currency Exchange (FX) markets also moved risk-on during the month, with the dollar falling against most major currencies. The improvement in risk appetite, lower energy prices, and better-than-expected Eurozone economic data supported the euro, which jumped 5.3% against the USD in November. GBP also benefited from USD weakness, supported by an improvement in risk sentiment and a new fiscal plan.

We have likely reached peak central bank hawkishness as headline inflation rates begin to cool and given the extent of tightening so far. We expect a further 0.50% of Fed rate hikes in 2022, and some modest additional tightening in Q1 2023. This may reverse later in 2023 if the economy tips into significant recession. Meanwhile, the European Central Bank is expected to continue to hike rates in order to manage inflation expectations. On the fiscal front, limiting the effects of the energy shock will be a primary concern in Europe while in China, support may come in the form of increased infrastructure investment.

US and European recessions in 2023 look increasingly likely given tighter monetary policy and the household income squeeze, although milder weather has helped limit the impact of the energy shock to activity.

Global Equities delivered strong returns in October as markets reacted positively to the month’s inflation prints and began to price in a potential slowing in monetary tightening. The bounce was led by US equities which were further supported by the start of the Q4 earnings season. UK equities delivered positive absolute returns, but were a notable laggard among developed markets, as political uncertainty weighed on the market. Conversely, negative returns from mainland China equity dragged Emerging Markets into negative territory.

Global Government Bonds delivered negative returns in October. UK political turbulence dominated UK bond markets at the start of October, although this calmed with the appointment of new Prime Minister Rishi Sunak. In Europe, the ECB delivered a 0.75% hike and both Germany and France released modestly higher than expected CPI prints. Ten-year Bund yields were little changed on the news. Bund-BTP spreads fell after reports of possible further common issuance and the deferral of any QT announcement to December. Treasury yields rose modestly as US CPI also saw a mild surprise to the upside in September at 8.2% compared to consensus of 8.1%.

The dollar fell over the month as investors digested the possibility of a slowdown in Federal Reserve’s policy tightening. Sterling rallied as the UK rowed back from the ‘mini’ budget delivered under ex-Prime Minister Liz Truss. The Euro also strengthened over the month, although this was primarily as a result of dollar weakness. The Bank of Japan left its ultra-low interest rates policy unchanged and revised down its forecast for economic growth in the current fiscal year.

Inflation remains sticky in the US, driven by the services side of the economy. Nonetheless, signs of cooling inflation are becoming more apparent as supply chains normalise and goods demand eases. Weakening economic activity may also provide disinflationary impetus towards year-end, particularly in the Eurozone. US growth held up in Q3, but a 2023 US recession remains highly probable.

Central banks remain hawkish amid persistently high inflation and have signalled a willingness to raise rates in the face of slower economic growth. Major tightening may be limited as the effects of earlier rate hikes begin to filter into the wider economy. The market expects a total of 4.25% of Fed rate hikes in 2022, leaving policy restrictive by the end of the year. Further rate hikes are likely in early 2023 with policymakers adopting a hike-and-see approach.

Fiscal policy will have an important role in limiting broader economic challenges including the cost of living crisis. This includes targeted fiscal policy support for households and businesses in Europe and increased infrastructure investment in China.

In September, the continuation of hawkish monetary policy, the Russia-Ukraine war, and mainland China property market volatility triggered a further fall in equity markets. The MSCI ACWI fell -9.5% in dollar terms. Notably, sterling weakness cushioned the equity market falls for UK investors, MSCI ACWI fell only 5.7% in GBP terms. The falls were led by Asian and US equities, while European markets proved more stable.

Global Government bonds provided relative stability over the month, falling modestly over the period. Gilts were in the spotlight, as markets priced in further BoE tightening after the UK’s ‘mini’ budget. While yields rose across the curve, pain was most acute at the long end. The market was somewhat mollified after the Bank of England announced a temporary long-dated gilt purchase programme. In the US, the Federal Reserve hiked 0.75% as expected, although indicated that rates were likely to peak at a higher level than previously forecast. The European Central Bank also raised rates by 0.75% during September.

The Federal Reserves hawkishness and rising risk aversion in the market drove the DXY 3.1% higher in September. Better-than-expected US economic data combined with inflation readings that surprised to the upside, reinforced the view that the Fed would move more aggressively to rein in inflation. Cable continued its downward trend in September, as weak economic data, high inflation, and the announcement of the UK government’s new fiscal strategy weighed on the currency. The EUR fell 2.5% against the USD in September given worse-than-expected economic data and double-digit inflation. USD-JPY jumped to nearly 146 after the BoJ’s unchanged monetary policy decision on 22 September. This spike prompted the central bank to intervene in the market to support the JPY, which fell rapidly to 141.0 following the announcement.

Commodity markets were down also. Brent crude fell 8.6%, as increasing fears over a global economic slowdown and a stronger USD overshadowed the prospect for tightening supply.

Amid sticky inflation, central banks are continuing to maintain a hawkish stance. Nonetheless, many indicators are pointing towards cooling inflation towards the end of this year and into early next year.

We expect a total of 4.25% of Fed rate hikes in 2022, leaving policy moderately restrictive by year end. Further US rate hikes are likely in early 2023 with policy makers adopting a ‘hike-and-see’ approach. Fiscal policy will have an important role to tackle growth headwinds. This includes targeted support for households and businesses in Europe and increased infrastructure investment in China.

Recession concerns are beginning to mount with a US recession looking increasingly probable towards the second half of 2023. The European energy crisis will dent growth, while policy and geopolitical developments are likely to continue to keep global market volatility high.