December Market Update 2022
Global equity markets had a weaker month in December. The S&P500 ended down -5.9% due to the US Federal Reserve (Fed) re-iterating their commitment to bring inflation back down to between 1% to 3%. The Fed's aggressive stance also pushed interest rates higher, with the US 10-year increasing 0.37% to 3.87%.
US employment data at the beginning of December continued to point toward a tight labour market as the US economy continued to add jobs despite the uncertain environment. This strong labour demand helped push wage inflation higher than expected at 5.1%.
Overall US inflation showed some signs of slowing with the CPI coming down from 7.7% to 7.1%, lower than the expected 7.3%. Inflation remains high, and the Fed are committed to lowering it. The Fed hiked by 0.5% in December. This was widely expected, but still slower than the 0.75% hikes used earlier in 2022.
Surprising news came from their forecast of future Fed Funds rates in the "Dot Plot", which shows where Fed committee members expect the Fed Funds rate to end up in the future. December's Dot Plot showed a significant increase in how high Fed committee members think Fund rates will go. Committee members are now expecting the rate to be at an average of 5.125% at the end of 2023, which is a step up from the 4.625% expected before December. This increase signaled that the Fed is willing to tighten financial conditions further to bring inflation back to tolerable levels. Many committee members expect the Fed Funds rate to get to 5% by early 2023, and then remain there for some time. This outlook caused rates to move higher and equities to weaken.
Both the European Central Bank (ECB) and the Bank of England (BoE) also hiked by 0.5% as expected. However, the ECB outlined a more aggressive stance, with upward revisions suggesting that interest rates may need to be hiked to higher levels than the market is expecting.
Despite the 0.5% hike, the BoE was less aggressive in their outlook for monetary policy. The statement released by the BoE indicated that members believe that inflation has peaked but may take some time to fully decline. Some members even voted to leave policy interest rates unchanged.
On the other side of the world, the easing of COVID restrictions in China was taken positively by markets. Although this reopening has caused a quick increase in case numbers, it will be a positive tailwind for the local and global economy as demand from China returns.
In New Zealand, economic data continued to show a relatively strong economy, with 3rd quarter GDP up 2%, significantly higher than the 0.9% expected. The reopening of the border and return of overseas tourists provided a fresh boost to demand. While international tourism remains well below pre-covid, the positive impact of domestic tourism is likely to begin to slow as household budgets come under more pressure from higher mortgage rates. Moreover, the higher-than-expected GDP will give the RBNZ food for thought over a further 0.75% hike in February this year.
NZ interest rates moved higher, with the 2yr rate up 0.33% and the 5yr up 0.42%. The market expects the RBNZ to them to raise the OCR by 0.5%, with a 40% chance of another 0.75% hike, after their meeting in late February.
The positive news from China, along with strong local data, helped the NZD hold its value against other currencies over the course of December, despite the fall in global equity markets. The NZD ended the month 0.84% higher vs the USD.
Looking forward, we expect markets to remain cautious. Although the China reopening story is positive, other economies are still adjusting to the tightening of monetary policy and the increased cost of living.