WeekWatch -‘ Last week, US equities experienced a strong bounce despite the Federal Reserve lifting interest rate’ July 22

The interest rate hike – the second in a row – came as no surprise, with the Fed saying it anticipates further increases to bring down inflation.

In the same week, economic data showed that the US economy contracted in the second quarter, leading many economists to say the US is in a recession. Economists typically define a recession as when a country suffers two quarters of GDP falls.

However, some have claimed the situation is more complicated than this. Following the rate rise, Fed Chair Jerome Powell said: “I do not think the US is currently in a recession. And the reason is there are just too many areas of the economy that are performing too well. And of course, I would point to the labour market in particular. It is true that growth is slowing, and for reasons that we understand really, that growth was extraordinarily high last year – 5 and a half percent – we would have expected growth to slow.”

Although the economy is struggling, US unemployment remains at a half century low of 3.6%, and wages continue to increase (even if they remain below inflation).

With the US continuing to increase interest rates and potentially being in a recession, it may have been surprising to see markets perform so well last week.

One reason for this was the language Powell used when talking about the future. The next rate rise won’t be for several weeks, and Powell said that while another large increase could be appropriate, this would depend on new data released by then.

“It likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation,” he noted.

With this seemingly softer stance, markets reacted positively, with the S&P 500 ending the week up 4.3%.

This capped off a relatively strong two weeks for equities.

Despite all the economic doom and gloom, David Bowers, Global Strategist at Absolute Strategy Research points out that since June 16, the MSCI World, S&P 500 and NASDAQ have jumped 8%, 11% and 14% respectively.

However, he warned: “Our instinct is to see this as a bear-market rally. Remember, this rebound in equities comes after a brutal sell-off in the first half of 2022. Let’s not forget that between 30 December 2021 and 16 June, the S&P lost 23% and NASDAQ fell 32%.”

In Europe, headline Eurozone economic growth of 0.7% beat market expectations, helping lift markets. The MSCI Europe Ex. UK finished the week up 2.4%.

Looking ahead, the situation is less rosy for European markets. Most of the GDP growth was driven by Spain, Italy and France. Germany – Europe’s largest economy – was flat.

Europe is facing multiple headwinds. Russia has reduced the amount of gas it is shipping to Europe, and it seems Putin intends to continue weaponising energy. Meanwhile the resignation of Italian prime minister Mario Draghi means the country will soon enter an election that could see populist leaders gain more central influence.

Azad Zangana, Senior European Economist and Strategist at Schroders noted: “We continue to expect reasonable growth for southern member states, which have not enjoyed a full tourism season since 2019. However, it’s clear from Germany’s performance that global capital investment has slowed in response to rising interest rates and concerns over growth. China’s draconian lockdowns have not helped matters either. With the heavy reliance on Russian gas to consider as well, it appears that the northern member states are particularly vulnerable going into the next two to three quarters.”

In the UK, the FTSE 100 finished up 2.0% thanks to a set of strong corporate earnings. The coming week will likely see another anticipated 0.25% rise in interest rates in the UK when the Bank of England meets.

The country continues to witness Rishi Sunak and Liz Truss promote their vision of the future of the Conservative Party. According to Mark Dowding, Chief Investment Officer at Bluebay: “It seems increasingly likely that Liz Truss will be chosen as the next UK Prime Minister by Tory Party members. This may mean more tax cuts (plus a desire to influence the Bank of England not to hike rates too much) in order to improve the growth backdrop. However, we see a real risk that this will end up perpetuating the inflation overshoot in the UK in 2023.”

BlueBay and Schroders are fund managers for St. James’s Place.

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