As it often does, the summer lull ended with a bout of volatility, leaving equity and bond markets down for the quarter. For UK-based investors however, a fall in the pound cushioned the severity and nudged returns into positive territory.
The value of the pound was dragged lower as the market repriced the peak in the Bank of England’s base rate amid slightly-better-than-expected inflation figures and evidence of economic weakness spreading to the service sector. Sterling fell back further in September as the MPC unexpectedly held interest rates steady for the first time since embarking on this hiking cycle.
On both sides of the Atlantic longer-dated bond yields drifted higher to reflect the notion that interest rates may now be ‘higher for longer’. After a quiet second quarter, duration returned to the fore as a key differentiator in bond markets. The longer end of the gilt curve repriced higher, and the short end moved lower, favouring shorter duration positioning. Corporate bonds were offered some insulation via narrowing credit spreads, until late in the quarter when spreads widened as the post-summer supply picked up and so too did market volatility.
Having risen over 20% during the quarter, oil prices will not be as favourable for inflation and the economy in the months ahead. In equity markets the Energy sector consequently performed well and aided the FTSE 100 relative to Developed Market peers, as did the falling pound given the multinational nature of the index. European equities fared poorly as the downturn in the Chinese economy raised fears for luxury goods retailers. After a subdued first half of the year, Indian equities performed well as the nation played host to the G20 summit, and in doing so hoped to showcase its manufacturing base as an alternative to China.
Turning to alternatives, UK property was not immune to the volatility however ended the quarter relatively unchanged.
Looking ahead, nearing the peak for interest rates in this cycle is a positive development for bond markets up to a point. Inflation remains the key determinant for longer duration assets, and with a headwind from oil prices to drop into the numbers in the months ahead, further uncertainty abounds. Having said that, markets are forecasting mechanisms. Some equity markets appear to have come to terms with recessionary conditions, and investors are looking for signs of improvement.
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