Quilter Cheviot|Weekly Comment

Inflation in focus as yields rise

Our weekly market overview from Quilter Cheviot

By Alan McIntosh, Chief Investment Strategist

Higher bond yields weighed on investor sentiment last week, with the MSCI All Country World index retreating 0.6% for its second consecutive weekly decline. In the UK government bond yields increased with the 10-year gilt yield up 14 basis points to end the week at 4.52%, supported by growing expectations of further monetary policy tightening from the Bank of England (BoE) following strong economic data. Derivatives markets are pricing two more 25 basis point increases from the BoE by year end.

UK economic activity picked up in June with the monthly GDP figure coming in at 0.5%, comfortably above a consensus forecast of 0.2%. Manufacturing and construction both outperformed while business investment rose strongly. UK stock benchmarks were little changed on the week, declining 0.1% but remaining 3.7% higher for 2023. The pound ended the week against the US dollar around the same level it began, at 1.27. This week all eyes will be on the UK consumer price index (CPI) release which is expected to show a further drop in the annual figure to back below 7%, after a reading of 7.9% last time out.

Eagerly anticipated US inflation data failed to provide the catalyst for a sustained market move, although on the whole the release was fairly supportive of price pressures easing back to more palatable levels in the world’s largest economy. US CPI increased 0.2% in July, showing an annual pace of 3.2% – a little lower than expected. Shelter costs continue to show some upwards pressure but a sizable drop in airline fares contributed to the lower than forecast reading.

Several Federal Reserve officials struck fairly dovish tones with comments last week, suggesting that the prospects of further rate increases are diminishing. Markets are pricing no further increases and decreases in the Fed funds rate to come next year. US stocks edged lower on the week, closing down 0.3% but remaining up by 17.4% year-to-date. European bourses moderately outperformed, eking out a 0.1% gain to leave 2023 returns at 12.0%.   

Second quarter results season is now pretty much over and on the whole results have been a little softer than in previous quarters, although there are still not many signs of bad news. Earnings have declined by approximately 7% year on year, broadly in keeping with expectations.

Bank tax

News that the Italian government would tax 40% of the net interest margin earned by banks caused a swoon in banking stocks last week as they experienced their largest daily decline since March when the sector was skittish following the collapse of US regional lenders. However, a clarification on the terms of the tax which appear to make it less onerous saw a recovery the next day, after it was announced that the tax would be capped at 0.1% of risk-free assets.

Banks have benefited from rising interest rates over the past 18 months, in many cases expanding their interest rate margin – the spread between the interest rate at which they can borrow money and the rate at which they lend it. Italian benchmarks ended the week down around 1.1%, underperforming their peers in Germany (-0.8%) and France (+0.3%).

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