In pursuit of price stability
Activity indicators released in July point to a general slowdown around the world. Evidence of slowing economic activity crystalised the tough trade off faced by central banks, that continue to battle still high levels of inflation by increasing interest rates. Ironically, it also set the scene for markets to discount a policy pivot from central banks which may see interest rate cuts in 2023. Perhaps the most prominent example was the market reaction to the US Federal Reserve, which increased interest rates by 75bps for a second consecutive time at the July meeting, but interpreted comments from Chair Jerome Powell as dovish, with an awareness of slowing economic momentum, leading to a broad decline in bond yields. This interpretation may of course be premature.

The ECB hiked policy rates by 50bps, the first hike in over a decade and a larger increment than the guided 25bps. Policy makers also introduced the Transmission Protection Instrument (TPI), intended to be a flexible tool to counter “unwarranted market dynamics” as the ECB increases interest rates, although it is unclear what magnitude of change or divergence in bond yields (mainly for periphery countries) would trigger its use. Italian bond yields widened by circa 30bps relative to German bond yields in the wake of the resignation of Italy’s prime minister, Mario Draghi, which also prompted the dissolution of the country’s national unity government. In the UK, Prime Minister Boris Johnson resigned, after a loss of support from his party. Conservative party members will cast a vote for one of two candidates, former chancellor Rishni Sunak and foreign secretary Liz Truss by early September. 
 

The USD lost ground in the latter half of the month as markets started pricing for a turn in US policy down the line, but the greenback still gained 1,2% on a trade weighted basis over the month, bringing year to date appreciation to 10,2%. Global bond markets rallied as the US 10-year bond yield declined to 2,6% into month end, with notable gains in the high yield market. In US dollar terms, the Bloomberg Global Aggregate Bond Index gained 2,1% in July.
 

Winter beckons
European gas prices increased by circa 31,2% in July on concerns that Russia might shut down gas supplies to Europe, while strikes in the Norwegian gas sector added pressure. While the latter was resolved, gas availability from Russia dropped to 20% during the maintenance period of Nordstream 1, the gas pipeline connecting Russian state-owned entity Gazprom and Europe. To deal with the immediate and uncomfortable reliance on Russian gas supplies, countries in the European Union are debating a proposal to decrease gas consumption by 15% in anticipation of winter. With this backdrop, the Euro briefly slipped below parity against the USD, before the boost from the ECB interest hike helped it recover. Estimates for second quarter growth in Europe showed surprising resilience, but with the ECB starting its interest rate hiking cycle, declining confidence, and the very real risk that Europe may be left short of gas supplies come winter, the outlook for the second half looks challenging.
 

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