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Ok. Got itThe spread of the Delta variant, ongoing Chinese regulatory tightening, geopolitical tension and policymaker actions all affected markets in August.
The spread of the Delta variant provided a headwind to markets in August, reminding of its ability to slow down and disrupt activity. The local impact and severity, however, differed between countries. The UK for example, lifted all remaining Covid-19 restrictions, even as daily cases were on the rise. Increasingly it seems that trade and supply chain interruptions, rather than lengthy lockdowns, have become the more enduring risk. Global vaccination efforts got a boost when the Pfizer/BioNTech vaccine became the first vaccine to gain full approval from the US Food and Drug Administration (FDA). Europe has now vaccinated 70% of its population, with programmes for booster shots already in the making. At the same time, economic activity indicators are moderating. Normalisation of data was always on the cards, given the distortions of last year, however, the prospect of decelerating growth momentum still gave market participants pause. Although the picture for economic growth is still robust, most recognise that the easy part of the recovery is coming to an end.
Chinese decision makers continued to tighten regulations across several industries where rules have been lax, but also to align business activity to the administration’s goal of ‘common prosperity’. Given the country’s proven ability to pursue long-term goals in the face of short-term trade-offs, more could be expected on this front. The withdrawal of the US from Afghanistan and subsequent resurgence of the Taliban has left an unsettling potential for geopolitical tension. Further developments in the region and the response of world leaders bears monitoring.
The tussle between the pandemic and policymakers made for a month of two halves. With virus concerns weighing on markets, August provided pause for a market correction, followed by recovery into month end as policymakers reassured markets of their accommodative stance.
The S&P 500 advanced 3,0% and the MSCI World Index 2,5%. Growth stocks benefitted from policymakers’ reassurance that interest rates will be lower for longer, which helped the technology-heavy Nasdaq 100 gain 4,3% over the month. Lockdown restrictions and tighter regulations weighed on Chinese stocks and, in turn, emerging markets. Neither this weakness, nor a decline in commodity prices, prevented participation in the rally in risk assets towards month end, helping the MSCI Emerging Markets Index gain 2,6%. Global sovereign bond yields rose modestly, while emerging-market and high-yield bonds benefitted from risk taking. In US dollar terms, the Bloomberg Barclays Globa Aggregate Bond Index returned -0,4% in August.
Every year, market participants listen in anticipation of any implicit or explicit policy guidance from the annual central banker gathering at Jackson Hole. In 2020, the US Federal Reserve confirmed a shift in policy to target average inflation of 2%. Fast forward a year and inflation across the world has risen in the US above the 2% mark. Some drivers will no doubt be transitory, while other areas of pricing pressure may prove to be more persistent. In any event, many would argue that progress has been made on the inflation target, even as the labour market recovery is still underway. It is therefore not surprising that markets have been on tenterhooks trying to understand how the US Fed is thinking about interest rates under this new regime.
Federal Reserve Chairman Jerome Powell’s speech touched on higher inflation and the continued risk from Covid-19, but more importantly emphasised that the decision and timeline for the withdrawal of liquidity (tapering) and interest rate hikes should be viewed separately. Markets rallied on this commentary, having been guided to focus their attentions on the tapering timeline for now. While the withdrawal of liquidity is unlikely to be without turmoil, policymakers are doing all they can to manage expectations around the path to normalisation – even if it remains unclear what a normal post-pandemic market or world will truly look like.