Global Equities Rise as Inflation Eases: A Market Overview

Global equities experienced a notable upswing last week, surging by 2.5% in local currency terms. This surge not only reversed the previous week’s decline but also re-established the upward trend observed over the past couple of months. However, when measured in sterling terms, the market showed a more modest increase of 1.1%. This difference can be attributed to the pound’s continued rally against the dollar, reaching $1.31. Despite this variation, markets have remained relatively stable in recent months.

In addition to the equity market, fixed income also performed well, with both Treasuries and Gilts delivering a return of approximately 1.5%. These gains were primarily influenced by a retreat in yields, which dropped by 0.2% from their recent highs. The main catalyst for these positive developments was the release of better-than-expected US inflation data for June.

The headline inflation rate in the US fell from 4.0% to 3.0%, a significant decline compared to last year’s peak of 9%. Similarly, the UK’s inflation rate is expected to show a deceleration in the upcoming data release, albeit to a still-elevated 8.2%. This decline in inflation rates signifies a positive shift, as wages are now rising in real terms instead of falling. Consequently, one of the major sources of downward pressure on the economy has been alleviated.

With the newfound optimism stemming from improved inflation figures, consumer confidence has experienced a considerable boost. In July, it reached levels close to a two-year high. Additionally, the second-quarter results of major US banks released on Friday showed no significant signs of consumer distress. On the contrary, these financial institutions continue to benefit from rising interest rates.

However, for the Federal Reserve, the core inflation rate holds greater significance than the headline rate. Although the core rate fell more than anticipated from 5.3% to 4.8%, it remains well above the Fed’s 2% target. Consequently, the Federal Reserve is far from celebrating and is expected to raise rates by an additional 0.25% to reach 5.25-5.5% in the following week.

While the United States demonstrates hope for a soft landing rather than the anticipated recession, China’s market sentiment could not be bleaker. The latest batch of economic indicators from China fails to instill much optimism. As expected, Chinese growth slowed significantly in the second quarter, with GDP rising by a mere 0.8% following a post-COVID jump of 2.2% in the previous quarter. Recent activity numbers for June also paint a relatively downbeat picture, casting doubt on the official 5% growth target for this year.

Nevertheless, the prevailing pessimism regarding China appears to be overdone, just as the optimism surrounding the US market and the tech giants driving its ascent seems exaggerated. Chinese GDP growth is still expected to be more than double that of the US for this year and the next. Additionally, China’s equity market trades at a price-earnings ratio of only 10.4x, which is nearly 50% lower than that of the US.

Furthermore, while the Federal Reserve is still contemplating rate hikes, Chinese authorities are poised to implement policy easing measures in the coming months. With inflation running at zero and youth unemployment exceeding 20%, the incentives for such action are compelling. The hope is that a politburo meeting later this month will endorse the proposed policy changes.

In the UK, where equities also trade at a P/E ratio of 10.4x and appear exceptionally cheap, the economic backdrop remains worrisome. Although the current picture shows activity stagnating rather than contracting, GDP remained unchanged in the three months leading up to May. Yet, the risk of a recession persists.

While the pressure on real incomes seems to be moderating, progress is slow. Furthermore, the impact of higher mortgage rates is yet to fully materialize, as the average two-year fixed rate has now climbed to 6.8%. Recent data revealed underlying wage growth at a concerning 7.3% across the economy and 7.7% in the private sector. Unless there is a significant shock in the upcoming inflation numbers, the Bank of England is likely to raise rates by another 0.5% to reach 5.5% in early August.

Amid the anticipation of peak rates in the UK, the pound has emerged as a beneficiary. However, last week’s gains were primarily driven by dollar weakness. Any further appreciation of the pound is expected to be primarily influenced by a continued decline in the overvalued US currency. It is worth noting that market expectations of UK rates peaking at over 6% may be somewhat overblown.

Global equities bounced back last week, reclaiming lost ground and resuming the upward trajectory witnessed in recent months. The positive market sentiment was bolstered by encouraging US inflation data, which indicated a decline in the headline rate. As wages rise in real terms, consumer confidence continues to improve. However, challenges persist in China, where growth has slowed, and market sentiment remains pessimistic. Conversely, the UK faces economic stagnation and the risk of a recession, even as the pound benefits from the expectation of higher interest rates. Overall, the global market landscape remains dynamic, with various factors shaping investor sentiment.

FAQs
1. What caused the increase in global equities last week?
The surge in global equities was primarily driven by the better-than-expected US inflation data for June, which eased concerns and boosted investor confidence.

2. How did the inflation rates in the US and the UK change?
The US headline inflation rate fell from 4.0% to 3.0%, while the UK’s inflation rate is projected to decrease but still remains relatively high at 8.2%.

3. What impact does falling inflation have on the economy?
A decline in inflation rates means that wages are rising in real terms, which removes a significant downward pressure on the economy and improves consumer sentiment.

4. What are the contrasting market sentiments between the US and China?
While the US market shows optimism with hopes for a soft landing, China’s market sentiment is considerably more pessimistic due to slower growth and less favourable economic indicators.

5. What factors contribute to the expectation of higher interest rates in the UK?
The Bank of England is considering raising rates due to concerns about underlying wage growth and the potential risk of a recession.