Global equities fell 3.8% in both local currency and sterling terms last week, bringing back memories of the short but sharp market correction in early August. The latest losses were strikingly similar to back then, both in terms of the leaders of the declines and the cause.
The US fell hardest of the major markets with a 4.6% decline, hurt by tech stocks which led the sell-off as in August and were down 6.5%. The UK, by contrast, once again held up relatively well with a fall of 2.3%, benefiting from its relatively high exposure to defensive sectors such as consumer staples.
Nvidia led the decline in the tech sector, falling as much as 13% back close to its lows a month ago and is now down 27% from its all-time high in early June. Ironically, there was no specific tech-related news to trigger this latest bout of nerves that AI has got overhyped and stocks been bid up to unjustifiably high valuations.
Rather, as in August, the sell-off was triggered by an outbreak of worries of a US recession. The culprits were identical to last time. A downbeat survey of manufacturing confidence started the jitters which were then reinforced by weak labour market data later in the week.
US payrolls did in fact post a larger gain in August than in July. The problem was that the increase was smaller than expected, previous gains were revised down and other indicators such as job openings posted a gloomy picture.
The truth is that the economic data at the moment is far from painting a consistent picture. There are a few omens that recession might be heading our way but as yet these remain outliers. GDP growth in the third quarter appears to be running at an annualised 2% or so, following a firm 3% gain in the previous quarter, and our view remains that while the economy has slowed somewhat, a recession remains unlikely.
Judging from the latest utterings of Fed officials, this also seems to be the view of the Fed. So, while a rate cut at their next meeting on 18 September looks a done deal to head off any further weakness in the labour market, it should be limited to 0.25%.
Fed officials have made it clear that the pace of forthcoming cuts will be very dependent on the data. And Wednesday’s US inflation numbers will not be unimportant in this respect. The expectation here is that they should give a green light to a rate reduction with headline inflation declining to 2.6% and the core rate unchanged at 2.9%.
In contrast to the rather circumspect comments of the Fed, the market is now pricing in aggressive monetary easing. Although it is looking for only a 0.25% cut this month, it is anticipating a 0.5% reduction in November and rates to be lowered by as much as 2% or more by next summer. This would leave rates at 3%, down from their current 5.25-5.5%. The market once again looks as if it is jumping the gun, as it has done on several occasions over the last year or two.
Still, this belief in rapid rate cuts meant that government bonds, as in the early August sell-off, provided a useful offset to last week’s losses in equities. US Treasuries returned 1.5% and 10-year yields are down to 3.7%, a full 1% below their high in May.
UK Gilts also gained 0.9% last week although yields have fallen rather less than in the US with 10-year Gilts still yielding 3.9%. This smaller reduction reflects the belief that rates are unlikely to fall as rapidly as in the US as a result of inflation pressures remaining rather higher, growth coming in stronger than expected recently and cautious comments from the Bank of England. The market expects no reduction later this month and UK rates to fall from their current 5.0% to 3.75% by next summer.
The ECB, however, does look certain to cut rates on Thursday by a further 0.25% to 3.5%, responding to recent benign inflation numbers and a renewed slowdown in growth. But centre stage for markets this week will be the US inflation data on Wednesday and the Harris-Trump debate on Tuesday which should be crucial in determining whether Harris manages to cement her recent move up in the polls.
Rupert Thompson – Chief Economist