The economics of optimism

Economic backdrop

Global equity markets maintained their upward trajectory in July 2023, bolstered by generally positive economic data, as well as investors’ optimism that the Fed may be able to curb inflation while piloting the economy to a soft landing. Emerging markets outperformed developed markets during the month.

The Pacific ex Japan region was the top performer among developed markets in July, bolstered mainly by strength in Singapore. The Nordic countries lagged the overall market due to weakness in Finland. Africa led the emerging markets during the month, benefiting from strong performance in South Africa and Senegal. The Gulf Cooperation Council (GCC) countries–Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates–were the primary laggards among the emerging markets in July, hampered largely by underperformance in Oman.

As widely expected, the Fed increased the federal-funds rate by 25 basis points (0.25%) to a range of 5.25%- 5.50% at its meeting in late July after pausing in its rate-hiking cycle in June. In a statement announcing the increase, the Federal Open Market Committee (FOMC) reiterated its commitment to reduce inflation to its 2% target rate and commented that it would “adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.” The FOMC also noted that the members “will take into account a wide range of information, including readings on labour market conditions, inflation pressures and inflation expectations, and financial and international developments.” At a news conference following the release of the rate-hike announcement, Fed Chair Jerome Powell said, “We can afford to be a little patient, as well as resolute, as we let this unfold. We think we’re going to need to hold, certainly, policy at restrictive levels for some time, and we’d be prepared to raise [interest rates] further if we think that’s appropriate.”

Global fixed-income assets saw mixed performance in July. Canadian bonds generally slumped, as corporate debt outperformed federal and provincial debt. Meanwhile, U.S. high-yield bonds registered positive returns and were the top performers within the U.S. market for the period.

Global commodity prices generally moved higher in July. The West Texas Intermediate (WTI) crude-oil spot price and the Brent crude oil price gained 15.8% and 13.3%, respectively, in U.S. dollar terms, amid expectations of dwindling supplies due to production output cuts from the Organization of the Petroleum Exporting Countries (OPEC). The gold spot price was up 4.1% for the month due to weakness in the U.S. dollar and investors’ speculation that the Fed may pause its rate-hiking cycle at its meeting in September. Following a sizeable upturn in June, the New York Mercantile Exchange (NYMEX) natural gas price declined 5.1% in July after the International Energy Agency (IEA) estimated that demand for natural gas in Europe will fall 7% for the 2023 calendar year. The IEA attributed its forecast to lower consumption in the power sector and rapidly expanding renewable energy-generation.

Wheat prices climbed sharply in mid-July after Russia withdrew from an agreement to export Ukrainian grain through the Black Sea. The plan had authorized Ukraine to export roughly 33 million metric tons (36 million tons) of food by sea since August 2022. More than half of the exports were being delivered to emerging markets. The U.S. and its allies condemned Russia’s pullout from the agreement. U.S. Secretary of State Anthony Blinken stated, “The result of Russia’s action today weaponizing food, using it as a tool, as a weapon, in its war against Ukraine, will be to make food harder to come by in places that desperately need it.” The wheat price subsequently fell later in the month amid some profit-taking by investors and as more grain flowed out of the country via land routes and the Danube River. The wheat price ended the month with a 2.3% gain.

In contrast to inflationary worries in most global economies, there are concerns that China may be experiencing a bout of deflation. According to the National Bureau of Statistics of China, the nation’s consumer-price index (CPI) dipped 0.2% in June, and was flat compared to the same period in 2022. Food and consumer goods prices were down 0.5% and 0.3%, respectively, for the month. The 2.0% year-over-year increase in costs for food, tobacco and liquor was offset by a 6.5% decline in transportation and telecommunications prices. Additionally, China’s producer-price index (PPI), which tracks the average change over time in selling prices received by domestic producers of manufactured goods, declined 5.4% year-over-year in June. Prices for the mining, raw materials, and processing industries fell by 16.2%, 9.5%, and 4.7%, respectively, during the previous 12-month period.

Central banks

• The Bank of Canada (BoC) hiked its overnight interest rate by 0.25% to 5.00% following its July 12 meeting. This was the second consecutive rate increase following a brief two-meeting pause in the hiking cycle. In support of this decision, the BoC noted that, outside of energy costs, inflation is still broadly above the bank’s target range. With no August meeting scheduled, the BoC’s next meeting is set for September 6.
• The Fed increased the federal-funds rate by 0.25% to a range of 5.25% to 5.50% following its meeting in late July. There was speculation that the Fed may need to implement additional rate hikes in order to cool inflation given the ongoing strength in the U.S. economy. As of the end of July, CME’s FedWatch Tool–which provides a gauge of the markets' expectations of potential changes to the federal-funds target rate while assessing potential Fed monetary policy actions at Federal Open Market Committee (FOMC) meetings– implied an 82% chance that the FOMC will leave the federal-funds rate unchanged at its meeting on September 19-20. The FedWatch Tool projected an 18% probability that the central bank will approve a 0.25% rate hike.
•  In the Bank of England’s (BOE) Financial Stability Report (FSR), which was released in July, the Financial Policy Committee (FPC) noted that U.K. banks are well-capitalized and maintain strong asset quality. However, the FPC also commented that some segments within the banking sector are more exposed to credit losses as borrowing costs rise, most notably commercial real estate lenders. The FPC stated that global commercial real estate markets “face a number of short and longer-term headwinds that are pushing down on prices and making refinancing challenging.”
• The European Central Bank (ECB) increased its benchmark interest rate by 0.25% to 4.25% following its meeting on July 27. In a statement announcing the rate hike, the ECB’s Governing Council noted, “The developments since the last meeting support the expectation that inflation will drop further over the remainder of the year but will stay above target for an extended period. While some measures show signs of easing, underlying inflation remains high overall. The past rate increases continue to be transmitted forcefully: financing conditions have tightened again and are increasingly dampening demand, which is an important factor in bringing inflation back to target [2%].”
• The Bank of Japan (BOJ) left its benchmark interest rate unchanged at -0.1% at its meeting on July 28. However, the central bank altered its yield curve control policy. While the BOJ will continue to allow the 10-year Japanese government bond (JGB) yield to fluctuate in a range of around +0.5% to -0.5% from its 0% target, the central bank indicated that this is now a suggested range. The BOJ set a rigid upper yield limit of 1.0% for the 10-year JGB. The 10-year yield rose sharply following the BOJ’s announcement, and ended July with a 0.20% increase to 0.60%—the highest level since April 2014.

Important information

SEI Investments Canada Company, a wholly owned subsidiary of SEI Investments Company, is the investment fund manager and portfolio manager of the SEI Funds in Canada.

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