Market Review 09/2022

Autumn is traditionally perceived by market participants as a season of possible crises and amplified volatility. In September neither geopolitics nor central banks added stability to the markets, quite on the contrary, working hard to increase overall nervousness. The only good news in September was that the month finally ended. We saw currency pairs setting new records and interventions in forex market, yields skyrocketing and equity markets hitting new lows. Central banks were having busy days hiking interest rates, while market participants were keen to price in even more aggressive hikes by the end of the year. We expected US yield curve to become even more inverted and were right as short-term yields rose more than those of longer maturities, though in absolute terms all yields were rising stronger than we thought they would.

US still sluggish, Europe continues to slide into recession

US manufacturing activity barely moved mostly due to a decrease in new orders – the ISM’s manufacturing PMI decreased to 50.9 in September compared to 52.8 in August. The survey’s forward-looking new orders sub-index decreased to 47.1 compared to 51.3 a month ago due to a weak demand in Europe, strong dollar and sluggish Chinese economy.

Manufacturing activity across Eurozone continued to decline in September mostly due to growing cost of living, as consumers remain cautious and cost of energy limits production, hence S&P Global final manufacturing Purchasing Managers’ Index decreased to a 27-month low of 48.4 compared to 49.6 in August. Inflation surpassed forecasts and hit 10.0% in September, which is yet another record level. Inflation was mainly caused by volatile energy and food prices but continued to broaden out and was present in virtually all categories. Consequently, Eurozone’s economic sentiment decreased significantly with the European Commission’s index at 93.7 points in September compared to 97.3 points a month ago.

Along with record inflation and the fastest rate hikes since the 70s, the stability of Europe, which is facing an energy crisis, is at stake. A number of German companies are thinking about moving production either to other European countries or even to the USA. The sabotage on the Nord Stream and Nord Stream 2 pipelines calls into question the very possibility of using the infrastructure to receive Russian gas. Although in September the price of gas in Europe fell by 27%, for the 3rd quarter as a whole the increase was 42%.

European and US equity markets

Dollar makes history

September proved to be a historical month for US dollar. EUR/USD currency pair fell from 1.0170 level all the way to multi-year lows of 0.9550. Pound sterling saw more suffering and dropped to all-time lows against the dollar almost hitting parity. As if this was not enough, FX market had to face a “long-forgotten phenomenon” – Bank of Japan had to intervene for the first time in twenty-four years to prevent yen from falling. History shows that one intervention is rarely sufficient to change trend, so we are expecting more action form BoJ (and other central banks). At the moment, we are contemplating buying Japanese yen in the USD/JPY 145-148 area and pound sterling closer to GBP/USD 1.02-1.04 levels, given such opportunity presents itself. Euro looks a bit more “complicated”, as the pair broke out of a large consolidation pattern and now, as long as it stays below 1.02-1.04 area, has a risk of diving well below EUR/USD 0.9550 support zone.

Benchmark 10-year bond yields

Oil and precious metals hit our targets

Precious metals felt «heavy» for the good part of the month but managed to produce a strong reversal in the last days of September and the first days of October. Recent rally in silver definitely brings it back on many radars, as the metal managed to get above 21 dollars per ounce mark, which is the first step to re-gain ground and to start building base for potential bull run. Now we watch XAG/USD 22-22.50 area as a major resistance level. Gold dropped to XAU/USD 1615 level just to see a reversal above 1700 mark. Now we watch XAU/USD 1720-30 resistance level for confirmation that the metal wants to go higher.

We were waiting for oil to drop to USD/bbl 80-85 area to return to comfortable long positions and when Brent was trading closer to 83 dollars per barrel we had to “get in” with our targets above USD/bbl 100 later this autumn.

High Yield bond Indexes

(A long) afterword

Jerome Powell said in one of his last speeches that he wants to see positive real yields “all along the yield curve.” Even if we take the PCE deflator (an inflation indicator used by the Fed), which was 4.9% per annum in August and which is significantly lower than the consumer price index (+8.3% in August), annual US Treasury yields should be at least 5%. The stock market was in no way ready for this, and it does not seem to believe that the Federal Reserve will be able to achieve a “soft landing” for the economy, provided it continues with aggressive monetary policy. Still, we are adding to our positions in shorter-term Treasuries at 4.25-4.50% yield level. Longer-term yield charts also produce more evidence that at least some consolidation is ahead in the near future, as participants are possibly pricing in more hikes than central banks can afford to deliver.

The desire of European governments to soften the energy blow by providing compensation or taxing the “extra profits” of energy companies was not met with applause from market participants. An example was the dynamics of the UK government bond yields, which added about 100 basis points in three days in response to the plans of the Liz Truss government to cut taxes and increase borrowing. The Bank of England was forced to intervene in the Gilts market and buy out 30-year Gilts after the yield on those exceeded 5%.

Despite the excellent start of October (rally in almost all asset classes), it is still too early to be in the risk-on mode. The world has “accumulated” a large number of uncertainties that can have a significant impact even on low-risk instruments. As the reporting season begins, we will follow the financial statements of companies and their forecasts for the next quarters, as the ECB and Fed meetings will take place only in November.

Gold price, USD/oz