September was a broadly negative month for most financial assets except the US Dollar. After coming in below expectations and relieving markets in August, inflation data surprised to the upside in September, dashing hopes of an early end to rate hikes. The Federal Reserve hiked rates once again and gave a hawkish outlook on monetary policy & the economy, driving renewed downward pressure on stocks. Treasury yields moved higher throughout the month, with the 10-Yr yield piercing 4% on Sept 28. Oil continued its recent downward trend, declining over 11% and finishing the month at $79/barrel.
• The Federal Reserve raised the fed funds rate by 75bps to a new range of 3.00-3.25%, with median FOMC expectations indicating an additional 125bps increase over the next two meetings.
• Aug CPI surprised to the upside both on a headline & core basis, coming in at 8.3% & 6.3% y/y and 0.1% & 0.6% m/m, respectively.
• After bottoming at $3.67 on Sept 19, gasoline prices rebounded to finish the month at $3.80.
• Home prices fell on a m/m basis according to both S&P/Case-Shiller (-0.2%) & the Federal Housing Finance agency (-0.6%) in July.
• Despite rallying to start the month, the S&P 500 declined 12.8% through month-end following the Sept 13 inflation surprise, reentering bear market territory.
• Consensus estimates for S&P 500 2023 EPS were revised down from $244/share to $239/share in Sept.
• Emerging Market equities slightly underperformed developed markets, likely in part due to global growth concerns & the strength of the US dollar.
• US equity funds saw $27.8bil in net outflows, though funds focused on generating income saw inflows of $4.7bil.
• Treasury yields rose 50-80bps across the curve in Sept, as investors increased rate hike expectations after the release of hawkish Fed projections
• Short/intermediate government & Treasury bond funds saw net inflows of $16.8bil in September, the highest ever monthly amount.
• HY spreads widened in Sept to 5.85%, while IG spreads marginally widened to 2.24%.
• Despite declining 3.8% in Sept, Bitcoin outperformed the Nasdaq on a monthly basis for the first time since February.
• Ethereum’s transition from proof-of-work to proof-of-stake was completed on Sept 15, a long-planned move that is intended to lower Ethereum’s energy consumption by over 99%.
Peak Hawkishness? Not So Fast
Buoyed by the prior month’s m/m CPI decline and unemployment rate uptick (leading some to believe the Fed could pivot sooner), stocks rallied through Sept 12. While investors expected further rate hikes, they also anticipated a slowing in the pace of rate hikes, suggesting that “peak hawkishness” had already been reached.
The upside CPI surprise put a kibosh in that story, as it showed a worrying acceleration in the core components. This led to investors adjusting their rate hike expectations higher, both for the end of 2022 and how high the Fed will go before stopping.
Not to be outdone, the Fed managed to give markets another hawkish surprise after its Sept 21 meeting. While the 75bps hike was expected, the median Fed projection indicated a higher rate in 2023 than markets had anticipated, in addition to significantly below-trend GDP growth and higher unemployment.
Stocks & bonds sold off significantly to reflect the changes to expectations, with bonds once again failing to diversify against stock losses during this higher inflation & interest rate environment.
UK Mini-Budget Shock
On Sept 23, the UK Chancellor of the Exchequer Kwasi Kwarteng unveiled a set of economic policies meant to boost growth, which included a lowering of the general income tax rate from 20% to 19%, and an elimination of the 45% higher income tax rate.
The market reaction to the move was sharply negative, as the tax cuts were to be financed by borrowing during a time when interest rates were already surging. In a span of three days, the yield on 30-Yr UK gov’t bonds surged by over 120bps & the GBP depreciated from $1.13 to $1.07 against the USD, its lowest level since 1985.
The sharp move up in borrowing costs placed significant strain on UK pension funds that followed Liability-Driven Investing, a strategy that seeks to hedge against liabilities. However, since yields rose—and bond values plummeted—pension funds were at risk of being margin called, which ignited fears of a crisis.
As a result, the Bank of England was forced to begin an emergency bond-buying program in order to stabilize conditions, pledging to hold them until financial stability risk subsides.
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