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July Market Update: let’s keep it real – rates hit record lows

July Market Commentary

For financial professionals only

In a nutshell:

  • Regulatory clampdown in China weighs on Asian and Emerging Market Equities.
  • Fed and Treasury comments support asset prices and inflation expectations.
  • Bonds rise on ‘stagflation’ fears, as real rates hit record lows.

What’s moving markets…

Waiting for “substantial further progress”

The Fed remained resolute for another month, leaving interest rates and the bond-buying program unchanged.

Fed Chair Jerome Powell suggested there’s still work to do on the labour market, with over 6 million fewer US jobs than before the pandemic, down from 10 million in December.

Powell expects inflation to remain above target for the coming months, but doesn’t see a risk to the economy or the Fed’s plans. However, the market is expecting changes sooner, as odds increased for at least one rate hike by the end of 2022.

‘Freedom Day’ fails to rescue retail

The EY Item Club has upgraded its forecast for the UK economy, predicting annual GDP growth of 7.6%, the fastest since 1941. However, during the week of 19th July, retail visits rose by only 3.3%, a 23.3% decline on the same period in 2019.

Bank of England Deputy Governor Dave Ramsden indicated that UK inflation, currently at 2.5%, could rise to 4% later this year. Michael Saunders from the Bank’s monetary policy committee suggested it may be appropriate to limit some of the stimulus.

However, another member of the Committee, Jan Vlieghe, signalled that he would oppose such measures.

Sterling advanced against most major currencies, amidst falling Covid cases in the UK.

Stagflation fears

Compared to last year, US inflation expectations remain inverted. Markets expect higher inflation over the next few years than the longer-term inflation levels. 10-year real yields (nominal less inflation) fell to record lows in the US, the UK, and the Eurozone. The prospect of stagflation, a low growth and high inflation environment, is becoming more concerning for bond investors. However equity markets remain strong with the major US and European indices reaching all-time highs.

State intervention weighed heavily on Chinese stocks, with 9 of the top 10 losses in July coming from China. Tech companies suffered from a campaign to address data security and financial stability, and the regulators have extended their reach to the education sector, gaming, and even ride-hailing companies. The fall in Chinese equities has been softened by a strong Yuan, in contrast to pullbacks of years gone by.

Asset class implications…

Equity

Due to the regulatory crackdown, Chinese equities suffered their worst monthly loss since 2018. Asia Pacific (ex Japan) and Emerging Market Equities fell sharply (-6.82% and -7.23% respectively) largely because of their significant exposure to China (34% and 38% respectively). Other regions posted positive returns – Europe leading the pack following upbeat earnings.

In the UK, mid and small-cap stocks outperformed larger companies, and M&A activity continues with bids for Meggitt, Sanne Group, and speculation of a renewed offer for Morrisons.

Bonds

Index-linked bonds outperformed all other asset classes, returning over 6% and reflecting the market’s concerns over inflation. Conventional Gilts also performed well, with nominal yields falling as the reflation trade cools off.

Returns for corporate debt were more muted – with lower quality areas of the market pulling down the asset class.

Asset classes in numbers

Name 1m 3m YTD 1yr 3yr
FTSE Actuaries UK Conventional Gilts All Stocks TR in GB 2.77 3.96 -3.05 -4.03 12.78
ICE BofA Global Broad Market Hedge GBP TR in GB 0.69 1.03 -3.88 -5.85 7.91
IA UK Direct Property TR in GB 0.87 2.22 2.92 2.60 0.16
FTSE All Share TR in GB 0.53 1.80 11.68 26.64 5.48
FTSE World Europe ex UK GTR in GB 1.61 5.27 12.69 26.63 28.92
FTSE USA TR in GB 1.60 5.00 15.24 29.04 55.51
FTSE Japan TR in GB -1.90 -0.43 -1.38 18.60 13.44
FTSE Asia Pacific ex Japan TR in GB -6.82 -5.50 -1.04 15.33 23.26
FTSE Emerging TR in GB -7.23 -4.64 -0.77 12.26 18.64

Source: FE Analytics, GBP total return (%) to last month end