After a month of political and market turmoil, the change in Prime Minister and a general recovery in sentiment globally steadied investor nerves. Gilt yields, the focus of attention during this crisis, have fallen to levels consistent with other government borrowing costs, reversing the bulk of any liquidity or risk premium that may have been applied. The removal of the short term Bank of England intervention, that was a potential flash point, passed without issue. It may be too early to assess if there is any long term scarring of the gilt market as a result of the market turbulence, as international investors in particular could be wary of reallocating to UK assets.
While there has been a fallback in Gilt yields, the Bank of England is still expected to increase interest rates by at least 0.75% in November. While there may be concerns around raising rates into a weakening economy, the Monetary Policy Committee will still feel that a significant rate rise is needed, at the very least to illustrate to the market that they are committed to fighting inflation. Nevertheless, while such a hike in rates will be one of the most significant seen in many years, it is not out of line with peers, with the European Central Bank and Federal Reserve also expected to lift rates by 0.75% in the month.
Sterling has also recovered, back to a level in line with the pre-Truss government, although still depressed on prior years. However, it is the particular strength of the dollar that is making the pound appear weak and a change in direction is likely to be linked once again to developments in monetary policy. Higher relative interest rates in the US have been a key reason for Dollar strength and any slowdown in rate rises may break this trend. A strong dollar also has implications for US competitiveness and the health of the global economy, making continuing strength difficult to sustain.
With inflation figures still elevated, higher interest rates are naturally expected in the short term. However, market attention is increasingly turning to the timing of any slowdown or pause in the rate rises, particularly from the Federal Reserve, which is ahead of most. Headline inflation in the US peaked in June and although subsequent declines have been gradual. The primary drivers of inflation over the last year are now reversing and should begin to contribute negatively over coming quarters. As examples, from their peak, oil prices, shipping costs, and wheat prices are down 28%, 70% and 17.6% respectively. Other significant contributors such as used car prices have stopped rising, and house prices, including rents, are falling month on month.
US quarterly earnings season showed a mixed picture, with many companies exceeding expectations, although the largest tech companies did disappoint investors. Generally, companies reiterated cautious outlooks for the fourth quarter, citing growing economic headwinds, however, it appears that investors have been pleasantly surprised that many companies have been able to pass on costs to customers and delivering top line growth.
