Markets remained volatile in September. The US stock market (S&P500) ended down -9.3% and US 10-year interest rates ended up 64bp. Inflation and central bank reactions continued to be the main source of volatility.
US inflation data surprised to the upside, with annual CPI of 8.3% vs 8.1% expected. Core inflation (excluding food and energy prices) also increased to 6.3%, which was higher than expected and signalled that inflation could be more entrenched than previously thought. This caused a significant move in US interest rates and the stock markets because the market had expected inflation to come back slightly. After the high inflation announcement, interest rate markets priced that there was a chance the next hike from the Fed could be a 100bp hike. The S&P500 fell -4.3% as a result.
The Fed ended up hiking interest rates by 75bp. However, the “dot plot”, which shows how Fed members expect short-term interest rates to track over the next few years, moved up significantly. This move was accompanied by the Fed Chair’s press conference, in which he reiterated they are going to do whatever it takes to get inflation back down. The Fed Chair also reaffirmed that this move would slow the economy by putting pressure on consumer spending and house prices. Interest rate markets were compelled to ratchet higher rate expectations for next year, putting pressure on equity markets to fall.
The UK also disrupted the markets when they announced a large, stimulatory, fiscal package. The package included tax cuts and an energy price cap. The energy price cap appears to be needed given the huge increase in energy costs UK households are facing over the winter. However, this large spending program caused the GBP to fall to record lows, triggering a spike in UK bond interest rates. UK 2-year rates moved 100bp over two days as the proposed fiscal package requires significant borrowing by the UK Government. The proposed package could also accelerate the UK’s soaring inflation, which could trigger further hikes by the Bank of England. The market now expects at least a 100bp hike at the Bank of England’s November meeting.
The Bank of England was forced to intervene and undertake targeted quantitative easing by buying longer dated UK government bonds in order to stabilise the market. This action saw interest rates move lower in the UK and across global markets. The fall in rates and perceived support by a central bank gave stocks a short-lived boost.
The Reserve Bank of Australia continued tightening monetary policy, hiking rates by 50bp in September, as expected by the market. The RBA remains more cautious on the outlook for further rate hikes – meaning the interest rate markets expectations of future levels remain lower in Australia than in other countries.
In New Zealand, economic data showed a somewhat firmer outlook than some had expected, suggesting the impact of rate hikes are perhaps yet to be felt in parts of the economy. Business surveys were a little more upbeat, but the shortage of labour remains the key capacity constraint.
The RBNZ did not have a meeting in September, but Governor Adrian Orr did make a speech in which he referred to the tightening cycle as “mature”. We believe he was trying to calm the interest rate market, which was pricing in more hikes than the RBNZ had outlined at their previous meeting. NZ 2-year and 5-year rates moved 31bp and 34bp higher, respectively. The RBNZ is expected to hike another 50bp in October. The market will be looking for any hints about how far rates could go, and how long they will stay up at these levels.
The NZD continued to weaken over the month, driven by the stronger USD. The USD saw strong tailwinds from US interest rates moving higher. The negative risk sentiment also drove investors to invest in the relatively safe USD over other currencies. The NZD saw pressure from lower commodity prices and fell to 56c against the USD, down 8.5%. This provided an offset to NZ investors with US stocks. However, the weaker currency will be an added cost to importers or people looking to travel overseas.