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Stock markets enter September on a soft footing after falling in August. A sharp rally for stocks that commenced in June unwound in the second half of last month as the Federal Reserve beat a hawkish drum at Jackson Hole. Oil markets were extremely volatile as traders unwound speculative positions as recession fears rose in the face of an increasingly tight physical market. The dollar gained and broke parity against the euro, hitting a 20-year high against the single currency whilst also making fresh two-and-a-half-year highs against the British pound, which had its worst month since 2016.  

Seasonality factors 

The second half of August was extremely tough for tech and growth stocks in particular as markets priced more aggressive tightening by the Fed – the yield on the 2yr Treasury, which is extremely sensitive to Fed policy, rose to its highest in 15 years. European and UK bonds were also sold off at the quickest pace for many years in August as the market decided that inflation will need more taming. 

Seasonal trends don’t offer much respite for beleaguered stock bulls, either. September is historically the worst month of the year for the Nasdaq 100. The ‘September Effect’ is noted across global equity markets but particularly noted in the US in election years. The Dow Jones has fallen in 11 out of the last 18 Septembers preceding midterm elections going back to 1950, according to The Stock Trader’s Almanac. 

Valuations still look concerning to many as the Fed looks to be more aggressive and maintain a restrictive policy stance for a while longer than many thought – no pivot. And whilst the second half of August saw the S&P 500 decline around 8% from its peak – which was almost 20% above its June YTD low – the index remains roughly 9% above its 2022 nadir. 

Federal Reserve 

Adding to the risks this September is the Federal Reserve’s next policy meeting, which if Jay Powell’s Jackson Hole speech is anything to go by, won’t be the last time the FOMC raises rates in the current cycle.  

Looking ahead to the meeting we can analyse Powell’s comments. There was a clear emphasis on restrictive policy being in play for some time – not stopping at neutral. Powell also pointedly said the Fed will use tools ‘forcefully’ and that it is prepared to inflict ‘pain’ – on the markets as well as households it would seem. 

NY Fed president John Williams backed up Jay Powell’s remarks last week with the following: “We’re going to need to have restrictive policy for some time … this is not something we’re going to do for a very short period and then change course.” 

Meanwhile, jobs data remains strong and consumer confidence is showing signs of returning. The hawkishness from the Fed, coupled with resilient economic indicators, mean market pricing indicates a roughly three-quarters chance the Fed opts for another jumbo 75bps hike.  

Energy markets: OPEC and Russia 

OPEC and allies convene for their monthly meeting on Monday, September 5th with the prospect of a supply cut being discussed. OPEC kingpin Saudi Arabia has flagged a willingness to cut output to stabilise prices, a sentiment supported by the United Arab Emirates. With oil markets teed up to expect a cut, prices remain volatile and sensitive to OPEC decisions. Meanwhile the head of the International Energy Agency said members could release more oil from strategic petroleum reserves (SPR). 

Meanwhile September began with the Nord Stream pipeline closed for maintenance work for three days. Whilst European gas prices for immediate delivery fell sharply towards the end of August, fears remain that Russian’s weaponization of gas flows will see deliveries dwindle still further. On a more positive note, European gas storage has increased to 80%, raising hopes that the tanks will be close to full come the winter.  

ECB 

The European Central Bank (ECB) will raise rates on September 8th– the only question is by how much. Rising inflation has seen the market increase bets for a more aggressive pace of hiking. Whilst there is broad consensus around 50bps, some on the Governing Council may prefer to follow the Fed in raising rates more. Money markets indicate a roughly 60% likelihood the ECB goes for a 75bps hike. Inflation pressures are acute: German inflation rose to a 40-year high 8.8% in August, whilst Eurozone flash inflation jumped to 9.1%. However, the prospect of an energy crunch this winter and slowing economic growth could keep the ECB in a more cautious mode than its US counterpart. Uncertainty means market moves could be volatile – we have already seen German bund yields spike by the most in a single month in many years.  

Italy Elections 

Staying with Europe and political risks to the Eurozone economy, stock markets and, crucially, the euro we look ahead to the Italian parliamentary elections, due to take place on September 25th. 

Our political analyst Helen Thomas, from BlondeMoney, examined the prospects in detail: 

“One thing is abundantly clear: political risk for Italy has gone through the roof. A new government of right-wing populists is about to take over just as the inflation crisis intensifies, war becomes protracted, and the ECB attempts new ways to manage its incomplete monetary union. Draghi’s gamble is that the unstable mess created by this election will give way to the return of a more sensible government at the next one.” 

Going back to the implications for markets and there is a clear risk that the new government is unable or unwilling to play by the Brussels rule book, which could affect the eligibility of Italian debt, which has already sold off relative to German paper, for the ECB’s new Transmission Protection Instrument (TPI), a tool that will shore up peripheral debt markets as the central bank tightens policy. 

The worry is that structural reforms required to get access to funds will be delayed or scrapped by the new government, which could put further pressure on Italian debt and prevent the country from being eligible for the TPI regime. 

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