Global stocks and bonds struggled in the third quarter, registering negative returns amid fears over slowing growth and aggressive monetary policy tightening. The US Federal Reserve, European Central Bank and Bank of England all raised interest rates in the quarter. Measured in sterling terms, the S& P 500 rose 3.5% for the quarter. The gains came from the weakness in sterling, which fell to an all-time low versus the US dollar after the UK government announced a fiscal package which was poorly received by markets.
The FTSE All Share Index fell 3.5% for the quarter. European equities fell 2%, and CPI inflation in the eurozone accelerated to a record 10.1% in September (from 9.1% the previous month). Emerging market equities ended the quarter down 3.6%. The prospect of continued rate hikes also weighed on bond markets. The 10-year US Treasury yield moved higher, briefly rising above 4% for the first time since 2008. GBP hedged global investment grade bonds fell 5% for the quarter.
As widely anticipated, the Fed raised rates by 0.75% for the third consecutive meeting while forecasting interest rates to peak at 4.6% next year with no cuts until 2024. The Fed’s hawkish stance continued to support the US dollar throughout the quarter. All figures are total return and quoted with GBP as the base currency.
Central banks continue to raise interest rates, but have a difficult balancing act in managing a slowdown in demand and a less optimistic economic outlook. The Bank of England and European Central Bank have raised interest rates slower than the Federal Reserve, and will need to do more in the coming months to combat inflation.
We maintain a mildly defensive stance. The bear market in government bonds is becoming more advanced but we think risks remain for yields until there is evidence that underlying inflation pressures are moderating and interest rate expectations go down. In this regard, the Federal Reserve is leading the policy tightening cycle in Developed Markets. Some emerging market central banks started their interest rate hiking cycles far earlier than their developed market peers. We think emerging market central banks could begin reducing interest rates sooner than developed market central banks.
We believe higher inflation will continue to impact returns on bonds while a slowdown in the global economy will weigh on equities. Market pricing of inflation suggests an expectation that inflation will fall back eventually, but the key question is whether the swift withdrawal of stimulus will dent economic growth prospects, triggering a recession.