Equity market weakness persisted in October as the S&P500 fell -2.2% in USD terms and US interest rates increased to levels not seen since 2007. Geopolitical tensions were at the forefront of investors’ minds as the conflict in the Middle East contributed to volatility in oil prices, long term interest rates and equity markets.
Data from the US indicated the economy remains resilient, prompting members of the Federal Reserve to reaffirm that interest rates would likely stay higher for longer. US inflation was also higher than expected at 3.7%, raising concerns that inflation could prove to be sticky.
Additionally, US interest rates were pushed higher because US government debt continued to grow to historically high levels, and investors now demand a higher interest rate on any new debt to compensate for the risk. Unfortunately, these higher interest rates also raise the cost of debt for other borrowers, and drive stock prices down to make their returns more competitive.
In Europe, the European Central Bank (ECB) left rates unchanged for the first time since they started hiking 11 months ago. Investors expected the European tightening cycle to end soon after weak economic data suggested higher interest rates were starting to bite. The ECB believe they have done enough to bring inflation back to acceptable levels, but interest rates may need to stay at these levels for longer to make sure inflation remains suppressed.
The Reserve Bank of Australia (RBA) left rates unchanged. CPI inflation was unexpectedly higher at 5.4%, and data over the month indicated the economy remains overextended. Interest rates in Australia subsequently rose
faster than NZ and US rates and the 5-year rate in Australia is now up by 0.45%. At the time of writing, investors estimated a 68% chance that the RBA will need to hike interest rates further at their November meeting to keep inflation down.
In New Zealand, data suggests that the economy is starting to slow. CPI inflation fell from 6% to 5.6% - below the 5.9% expected by the market. Employment fell in the 3rd quarter, pushing the unemployment rate up to 3.9%. These outcomes are an expected product of the RBNZ’s monetary tightening and have lowered the probability of another hike occurring from here. In fact, market data shows that investors now expect the RBNZ to leave rates unchanged for the next 10 months before cutting.
This weak domestic economic data led to lower interest rates for shorter term maturities, with the 2-year rate decreasing by 0.12%, whilst the 5-year rate (which is more affected by global rates) increased by a relatively small 0.1%. The combination of strong US data, higher US rates, geopolitical risks and weak data from NZ drove the NZD down 2.9% to levels not seen since November last year.
Investors are keenly monitoring new economic data to assess how inflation and growth will develop from here, particularly with the view that interest rates could remain higher for longer. Resilient data from the US suggests that a soft landing is still possible.