An interesting month for markets - May 2023 

 

For most of May, investors had their focus firmly trained on the US government, as infighting and political posturing over debt ceiling negotiations grew. The debt ceiling is the maximum amount the US government can borrow to fund its spending, with any increase needing Congress approval. This is certainly not a new situation but becomes more politicised whenever the Senate and House of Representatives are controlled by opposing parties. Beyond this, interest rates and inflation were the key drivers of markets in May. While there were no surprises on the interest rate front, with the main central banks raising rates as expected, inflation data, particularly in the UK, caused some waves for both equities and bonds.


US politicians finally agree on the debt ceiling

  • The unrest in markets over the impending debt ceiling in the US gathered pace throughout May, as fears grew that an agreement would not be reached, meaning the US would default.
  • Janet Yellen, US Treasury Secretary, continued to issue stark warnings to both parties that they were playing with fire by politicising the issue, reiterating that a default would cause “economic and financial catastrophe”.
  • After much infighting resulted in increased market volatility, the month ended with a compromise reached between President Biden and the Republican Party that looked like averting a US debt default.

No interest rate surprises from the central banks

  • Interest rate increases of 0.25% from the Bank of England (BoE), US Federal Reserve (Fed) and European Central Bank (ECB) were in line with expectations, but investors continued to question how much longer rate hikes would continue for.
  • While the Fed appeared to be nearing, or potentially already at, peak rates, the BoE’s rate hiking cycle appeared far from done, with UK inflation persistently elevated.
  • The ECB’s rate hiking programme also appeared to have further to go, with markets pricing in an estimated two further 0.25% increases before the end of the year.

The UK’s economic problems are still far from under control

  • While inflation in both the US, and to a slightly lesser extent Europe, has eased somewhat, inflation in the UK has been stubbornly persistent.
  • UK Consumer Price Index (CPI) inflation, fell to 8.7% in April, the lowest since March 2022, but was still higher than the average economist forecast of 8.2%.
  • Core UK inflation, which strips out volatile food, drink, energy and tobacco, increased despite the headline fall, while food price inflation at 19% was close to a 45-year high.
  • There were small nuggets of good news with confirmation the UK economy grew in the first quarter of the year, albeit by just 0.1%, and the International Monetary Fund upgraded its UK forecast from recession to growth in 2023, but nothing sufficient to balance out the disappointment of the CPI data.

The recovery in China has come to a grinding halt

  • After the initial wave of optimism of late 2022 and into the early months of this year, the economic recovery in China has since showed further concerning signs of faltering.
  • Imports fell by 7.9% year-on-year in April, with forecasts expecting the number to remain unchanged following a 1.4% fall in March. Manufacturing activity also continued to contract.
  • Investors are now looking towards China’s policymakers to take further action to help reignite the recovery. 

Summary

After April’s UK CPI inflation figures were higher than forecast, investors seemingly took the view that the BoE would need to raise rates higher than previously expected. This weighed heavily on both the value of UK government debt and UK equities. Chinese equities also struggled, with the strong economic recovery predicted since the relaxation of lockdown restrictions last year still yet to materialise.
More positivity in May was found in the US and Japanese equity markets. Optimism continued to build in the US tech sector, as the wave of excitement over artificial intelligence swept through investors. After a very challenging 2022, the NASDAQ index (which is dominated by the big tech companies) has experienced a sharp reversal in fortunes so far this year.

Japan also continues to perform strongly, and its economy is in a very different position to the US, UK, and Europe. Whereas central banks in western economies are doing everything in their power to bring inflation back down, in Japan, which has spent the last 30 years trying to stave off deflation, inflation is being welcomed.