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MORE VOLATILITY FOR BONDS AS CONSUMER DEMAND DRIVES SURPRISINGLY STRONG US GROWTH
Data Sourced from FE Analytics, and Bloomberg Finance LP
MORE VOLATILITY FOR BONDS AS CONSUMER DEMAND DRIVES SURPRISINGLY STRONG US GROWTH
This week has been notable for the volatility in bond markets. On Monday, the ongoing sell-off in US government bonds pushed yields even higher and the yield on US 10-year Treasury bonds rose above the psychologically important level of 5% – a level last seen in 2007. The prompted a swift rally as some investors considered the rally has gone too far. But remarkably robust US consumer spending helped to deliver surprisingly strong economic growth and the now familiar good news is bad news response followed. The logic goes that if consumer demand is this strong and wages are rising above inflation then the Federal Reserve will act more aggressively to tame inflation.
The level of volatility shows the amount of uncertainty in markets at the moment. Investors are waiting for a signal that central banks are going to be forced to change their approach. A few months ago an analyst’s review of inflation noted the US consumer was determined to buy anything that is not nailed down and demand is still strong enough to ensure the higher for longer scenario remains the dominant force in markets for now.
US: UNCERTAINTY SPURS MORE VOLATILITY FOR US GOVERNMENT BONDS
US government bonds continued to experience very high volatility. The sell- off continued at the beginning of the week and bond yields, which move in the opposite direction to bond values, hit levels last seen in 2007. This sparked a brief rally as some investors considered the sell-off to be overdone. But Treasury bonds fell again as very strong consumer spending helped US GDP grow far more than expected and this makes the Federal Reserve more likely to keep rates high to bring inflation back to target.
US equities also declined as US tech firms’ earnings updates failed to meet expectations. Microsoft’s shares increased as integration of artificial intelligence in its cloud services contributed to higher revenues growth. But Alphabet and Meta Platforms (the owners of Google and Facebook, respectively) saw their shares fall. Both companies reported rising revenues but the growth in Alphabet’s cloud computing business fell short of forecast and Meta said demand for online advertising is weaker due to the uncertain economic outlook.
EUROPE: ECB LEAVES RATES UNCHANGED AS ECONOMIC ACTIVITY SLOWS
The European Central Bank left interest rates unchanged at 4%. The decision was widely expected and financial markets were unmoved by the decision as the ECB tries to balance the need to bring down inflation with evidence of a slowing economy. Consumer sentiment in the continent remains poor and economic output has declined due to less activity in the services sector. Although there was no change in rates at this meeting, the ECB said it is still committed to keeping rates high to ensure inflation is brought under control.
There is a similar picture in the UK although the decline in the services sector was offset by an increase in manufacturing activity. The unemployment rate in the UK increased to 4.2%, however, the Office for National Statistics has changed the way it calculates its employment data and warns the new figures are what it calls “experimental”. This leaves the Bank of England facing the same dilemma as the ECB at its interest rate meeting next week.
EQUITIES: BANKS CONTINUE TO BENEFIT FROM HIGHER INTEREST RATES
UK bank stocks declined despite relatively positive updates from many UK and European lenders. High central bank interest rates have helped boost bank lending margins and Lloyds, Santander and Deutsche Bank all reported higher revenues and profits for the last quarter. Lloyds also reported lower default rates on its lending and reported an inflow of customer deposits as savers seek higher interest rates for their savings.
However, disappointing updates from Barclays and Standard Chartered pushed shares down. Barclays reported an increase in revenues but profits declined and it pointed to potential for more defaults. Standard Chartered declined due to its exposure to China. Despite this week’s declines the banking sector has been one of the better performing sectors in 2023, as shares have risen considerably more than the broad UK index. There are signs that conditions are getting a little tougher as interest rate cuts would erode profit margins and high interest rates have also significantly reduced the demand for new mortgage borrowing.
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