Tough week for markets amid worries over rising interest rates

Yesterday’s softer US inflation reading has helped to settle stock markets but we still expect further rate increases and trade tensions to remain a concern.

12 October 2018

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

Craig Botham

Craig Botham

Senior Emerging Markets Economist

Equity markets have had a poor week as concerns over rising bond yields and a potentially more hawkish Federal Reserve (Fed) weighed on sentiment.

Concerns over rising imported prices due to new tariffs, and rising oil prices, led some to fear that the US consumer price index (CPI) inflation release this week could have been higher than expected. This may in turn have caused the Fed to step up the pace of interest rate hikes. However, CPI inflation was lower than expected, which has since helped lower Treasury yields and settle equity markets.

The global stock market sell-off earlier this week started in US markets, where investors took profits on parts of the market that had outperformed the most this year, and were on high price-to-earnings ratios1. The rise in bond yields is at a critical point, as the two-year Treasury yield had risen to overtake the dividend yield being offered by the US S&P 500 index at the start of the year. This calls into question the valuations, especially on technology stocks which have performed so well this year.

The sell-off then spread to Europe, where investors are also concerned over the impact of the US-China trade war on European exporters. The situation in Italy has not helped either this week as talks continue over its 2019 budget.

Emerging markets (EM) and Japan also suffered a sell-off in response to the correction in the US. One interesting aspect of the sell-off was that it seems to have been more concentrated in markets exposed to the US-China trade war. China, Korea and Taiwan were amongst the hardest hit EM equity markets. This suggests that market participants see greater vulnerabilities here than elsewhere.

We do not think that rates have finished rising in the US, or that trade tensions are set to de-escalate yet. Consequently, more volatility for global equities seems likely as the markets adjust to a lower liquidity and politically tenser world.

1. The price-earnings ratio (P/E ratio) values a company by measuring its current share price relative to its per-share earnings.

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