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August was a tale of two halves - the first few weeks saw a continuation of July's rally, with investor sentiment buoyed by hopes of a policy pivot by the Federal Reserve. Later in the month, concerns about inflation grew once again. Jerome Powell's indication that inflation control remains the Fed's number one priority contributed to a reversal in sentiment, resulting in a retreat for major equity and fixed income indices in the latter half of the month.

Inflation continued to dominate headlines both at home and abroad. In the US, headline inflation came in at 8.5% for the 12 months ended July, after rising 9.1% the previous month, raising hopes that in the US, at least, inflation had peaked. In contrast to the UK and Europe, where inflation has been driven predominantly by the skyrocketing price of natural gas, in the US inflationary pressures remained more evenly spread, with roughly equal contributions from energy, services and goods. The rapid fall in gasoline prices through August also suggested that the energy contribution is set to fall further.

There was no such respite for UK consumers, with the Consumer Price Index (CPI) coming in at 10.1% for the 12 months ended July, up from 9.4% in June. With the energy price cap set to rise in October, and then again early in 2023, analysts are now forecasting truly scary levels of inflation. According to the US investment bank Goldman Sachs, UK inflation could hit 22.4% next year if wholesale gas and electricity prices continue to spiral over winter. Across the channel, the picture was no less downbeat – Eurozone inflation surged to another record high in August, up 0.2% month-on-month to 9.1% in August. Soaring energy prices are now threatening to plunge the entire region into recession, a situation that will likely be exacerbated by another planned shutdown of Nordstream 1 at the start of September (European ministers strongly refute that the shutdown is necessary).

Signs that US inflation may have peaked gave investors cause to believe that the Fed had passed the peak of its policy to beat inflation. The prospect of a pivot to a less aggressive stance helped support risk assets in early August, not least beleaguered fixed income assets, which have suffered historic declines year to date. However, any prospect of a prolonged summer rally was dashed by Jerome Powell. During his address to the global central banking conference in Jackson Hole, Wyoming, Powell made it clear that fighting inflation remained the Fed’s top priority, even if some ‘pain’ was required. In this case, pain referred to the central banks preference to continue raising interest rates and shrinking its balance sheet. The comments led to a sharp retreat for most developed market indices.

Markets

Moving on to markets, and despite strong gains early in the month, Powell’s comments and the resulting end-of-month sell-off left many major indices in the red through August. Aggregate world equities finished the month 3.9% down, erasing almost half of the previous months’ gains. In the US, markets were down 4.2% on aggregate, with technology-heavy indices retreating 4.6%. While Q2 earnings were generally at or above expectations, these figures are backward looking and are yet to reflect inflationary pressures, suggesting there may be further stormy weather ahead.

In the UK, the defensive nature of the large-cap index shielded investors from losses sustained elsewhere, retreating a modest 1.9% through August. The main index was supported by strong gains from the oil majors, with BP in particular returning 11.6% over the month, as oil and gas prices remained elevated. In contrast, the mid-cap index had a bruising August, retreating 5.5% over the month. European investors also suffered significant losses in August, with the main French and German indices retreating 5.0% and 4.8%, respectively. Europe’s energy crisis grew ever more acute, as the squeeze on gas supplies was compounded by drought that curtailed output from French nuclear reactors and limited the transportation of coal along the Rhine.

Japanese equities were the standout performers in August, with the main index gaining 1.2% over the month.

Emerging markets were up 0.5% in August, as economic momentum in regions such as India and the Middle East (the latter supported by elevated energy prices) offset losses in China. August was a challenging month for the world’s second-largest economy, as a heatwave and stifling drought disrupted supply chains across its industrial heartlands. In provinces such as Sichuan, which rely heavily on hydropower for electricity generation, low river flows resulted in local government instructing factories to shut down in an effort to conserve energy. Weather disruptions, coupled with lingering weakness in the property sector, saw aggregate Chinese equities retreat 2% in August.

Fixed Income

The prospect of a more prolonged cycle of interest rate hikes also weighed on fixed income markets. Global Investment Grade bonds were down 3.7% on aggregate. Gilts had a particularly tough August – yields on the 2- and 10-year gilt both rose sharply, finishing the month at 3.0% and 2.8%, respectively. The yield on a 10-year US treasury also rose significantly, finishing the month at 3.2%. Emerging market debt was the most resilient fixed income sector, retreating just 1.2% over the month. Further easing of monetary policy by the People’s Bank of China (PBoC) helped support Chinese debt over the month.

Commodities

In general, commodity prices declined, with the aggregate index retreating 2.7% in August. The spot price for a barrel of Brent crude fell 6.4%, as recession fears and weakening demand overshadowed supply concerns. Precious and industrial metals also fell. Following a sharp decline in June, wheat prices saw a small uptick in August. Despite a deal to allow ships to resume exports from the southern Ukrainian port of Odessa, supply concerns dragged on – this year’s Ukrainian wheat harvest is expected to be almost a third smaller than last year, due to damage and the loss of land to Russian forces.  The natural gas spot price rose sharply, up 11.3% over the month, as global demand, exacerbated by the Russia/Ukraine conflict, continued to outstrip supply.  

Currencies

Finally, in the currency markets, the Fed’s hawkish stance continued to support the dollar. Both the pound and euro lost ground, the latter reaching parity with the dollar for the first time since 2002, as the probability of an energy driven recession in the Eurozone increased.  

| Whitechurch Securities Ltd Investment Team | August 2022 |

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FP3429.02.09.2022

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