Muzinich Weekly Market Comment: Too little, too late?

August 5, 2024

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In our latest roundup of developments in financial markets and economies, we look at whether the effects of a delayed policy response by developed-market central banks are starting to materialise.

July was positive for bond investors. The main catalyst was soft data and rising political uncertainty, which pushed governments to announce policy measures intended to support growth. Both the US and German government bond curves bull steepened, with short-term yields falling more than long-term yields. Meanwhile, China’s 10-year government bond yield fell to a record low (see Chart of the week).

Falling government bond yields helped investment-grade credit marginally outperform high yield, although the latter also enjoyed a strong July as spreads tightened in response to policy announcements and a lack of supply. US, European and EM credit outperformed the Bloomberg World Large & Mid Cap equity index, with US credit the pick in investment grade and high yield.

Most currency markets were range bound (+/- 1%), the exception being the Japanese yen, which appreciated 7% versus the US dollar as investors drew confidence from Bank of Japan (BoJ) policy announcements.

Industrial metals and energy prices weakened as concerns over global growth picked up. Gold appreciated 5%, not unexpectedly given falling yields, growth fears and political uncertainty. The story in equities was driven by weaker outlooks for earnings and valuations, and a rotation out of large cap and technology stocks into small caps, with the S&P SmallCap 600 index closing the month 11% up on the S&P 500.

Hike, hold, cut?

Three central banks took centre stage last week. First up was the BOJ, which on July 31 hiked policy rates from 0.0-0.1% to 0.25%,^[1] surprising many in the market. The BoJ also announced plans to gradually reduce its monthly purchases of Japanese government bonds from the current level of ¥5.7 trillion (US$39 billion) to ¥2.9 trillion by the first quarter of 2026.

Speaking at a press conference following the announcement, BoJ governor Kazuo Ueda said additional hikes will be data dependent, noting “it’s better to make adjustments as early as possible, even if only little by little”.^[2]

Markets are currently pricing in a further 15 basis points (bps) hike in the fourth quarter.

Next came the US Federal Reserve, which decided to leave policy rates unchanged for the twelfth meeting in a row.^[3] However, there was a subtle change in language in its policy statement. The Fed said it will be “attentive to the risks to both sides of its dual mandate” of maximum employment and inflation, rather than focusing mainly on inflation, which has characterised its communications over the past 2 years.

In the press conference following the announcement, Fed chair Jay Powell made the central bank’s next action even clearer, stating “a reduction in our policy rate could be on the table as soon as the next meeting on September 3”.^[4] The overnight interest rate swap market is now pricing in 25bps cuts at each of the Federal Open Market Committee’s next three meetings.

Finally, the Bank of England (BoE) announced a surprise 25bps cut to its policy rate, the first cut since the first quarter of 2020.^[5] The decision was seen as a “hawkish cut”, with the BOE’s monetary policy committee voting in favour by a narrow 5-4 margin.

BoE governor Andrew Bailey told reporters: “We need to make sure inflation stays low and be careful not to cut interest rates too quickly or too much.”^[6]

The next cut is priced in for November, which will give the BoE three further sets of inflation data and the new Labour government's Autumn budget to gauge whether its inflation objective has been achieved. Long-term neutral policy rates for the UK are estimated to be 3.25%.^[7]

Facing the facts

After waiting all year for policy adjustments to be confirmed, investors have moved from buying the rumour to selling the fact.

Over the summer months, investors will be looking for confirmation that either central banks have achieved their dream scenario of a soft landing or, as some fear, they have been too slow to adjust policy, causing imbalances that could lead to a hard landing.

If the latter narrative starts gaining momentum, investors may consider again whether it is time to rotate out of equities into bonds.

Chart of the Week: Are zero rates possible in China? 

Index performance is for illustrative purposes only. You cannot invest directly in the index.

Source: Investing.com, as of August 2, 2024. AMBMKRM - China’s 10-year government bond. For illustrative purposes only.

References

[1] Bank of Japan, ‘Change in the Guideline for Money Market Operations and Decision on the Plan for the Reduction of the Purchase Amount of Japanese Government Bonds,’ as of July 31, 2024
[2] Bloomberg, ‘BoJ hikes interest rate, unveils plan to halve bond buying,’ as of July 31, 2024
[3] Federal Reserve, ‘FOMC statement’ as of July 31, 2024
[4] Federal Reserve, ‘FOMC press conference,’ as of July 31, 2024
[5] Bank of England, ‘Monetary Policy Summary and minutes of Monetary Policy Committee meeting’, as of August 1, 2024
[6] Reuters, ‘Bank of England cuts rates from 16-year high,’ as of August 1, 2024
[7] Bloomberg, as of August 2, 2024

Past performance is not a reliable indicator of current or future results.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of August 2, 2024, and may change without notice. All data figures are from Bloomberg, as of August 5, 2024, unless otherwise stated.

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