Weekly house view | Coup, what coup?

Interest rate hikes from the Swiss National Bank (SNB), Bank of England (BoE) and Norges Bank last week showed central banks are in no mood to let up in their fight against inflation. The SNB’s expected 25bps rise was accompanied by a hawkish statement about “second round effects”. Like the European Central Bank (ECB) the previous week, the SNB revised up its inflation forecasts for 2024 and 2025, suggesting that high interest rates could persist. The BoE’s 50bps hike surpassed expectations following data showing a rise in core inflation to 7.1% in May from 6.8% in April. After the BoE hike, the gilt curve became even more inverted and the GBP reversed its previous gains as markets start to discount the recessionary effect of such rises. Britain's public sector net debt surpassed 100% of gross domestic product in May for the first time since 1961 as borrowing came in higher than expected. The Norges bank hiked by 50bps (consensus was 25bps. 

In the US, Federal Reserve Chair Jay Powell said two more hikes in 2023 is a “good guess” and confirmed that banks’ capital requirements could be raised by “20 percent”, with an exception for smaller lenders. His hawkish comments, combined with weaker US Purchasing Managers’ Indices, brought equities lower. Small caps, which are generally more leveraged in the US, in particular were hit. We are underweight small caps. Profit warnings from chemical and logistics companies also highlight the slowdown in cyclicals and point to a manufacturing recession. Markets are starting to price in interest rates staying higher for much longer and yield curves are increasingly inverted, creating a more challenging environment for equities.

In the euro zone, where the ECB is also in hawkish mode, services activity looks to be losing momentum as the preliminary services PMI declined by 2.7 points in June to 52.4, while the downturn in manufacturing activity deepened. France and Germany were especially weak as banks’ lending conditions tighten. For European markets, this translated into a further inversion in sovereign curves (2Y rising and 10Y declining) and a retreat in equities. Cyclical sectors were the biggest losers indicating that the market is anticipating economic contraction.

The events of the weekend in Russia, where a mutiny led by warlord Yevgeny Prigozhin quickly gave way to a deal with Moscow to end the insurrection, show the situation there is fluid and anticipating such events and their outcome close to impossible. Therefore, we continue to believe volatility should be used as an asset class, especially when the price for protection is low. We note also that EU officials last week approved an 11th package of sanctions against Russia.