Equity markets: in December too, stock markets get a central bank scare
More economic data point to easing inflationary pressures, but central banks continued to surprise in December with a restrictive outlook for their monetary policy. This reversed the more positive trend on financial markets that had emerged due to the recent better inflation figures in the US. Stock prices fell, making December a carbon copy of the entire year 2022.
European stock markets outperformed the US in December, where valuations are still somewhat higher and growth stocks weigh heavier in market indices. The US stock market is consequently more sensitive to the interest rate outlook. The performance in the last quarter allowed European stock markets to completely level out their performance gap with the US by the end of the year. In the first months of the year, European stock markets performed significantly weaker due to the war in Ukraine and the energy crisis. Emerging markets showed a mixed picture in December, with positive performance in Eastern European markets and negative in Latin America. That divergent performance is the mirror image of what was the case during the first months of the year. The Chinese stock market had a strong December due to the Chinese government's changed stance on its zero-Covid policy. However, for the full year, the performance remains extremely weak.
In both the US and Europe, value stocks performed significantly stronger than growth stocks in December. They continued the trend that prevailed for most of the year.
|MSCI EMU NR||-3.6%||12.8%||-12.5%||-12.5%|
|MSCI EUROPE NR||-3.5%||9.5%||-9.5%||-9.5%|
|MSCI USA NR||-9.2%||-1.8%||-14.6%||-14.6%|
|MSCI JAPAN NR||-3.3%||3.9%||-11.2%||-11.2%|
|MSCI EM. MARKETS NR||-4.9%||0.7%||-14.9%||-14.9%|
|MSCI AC WORLD NR||-7.3%||0.8%||-13.0%||-13.0%|
Bond markets: higher interest rate in 2022 and in December
In early 2022, the German 10-year rate was still negative at -0.15% and the rate on its US counterpart was 1.5%. At a time when post-pandemic supply chain bottlenecks had already put strong upward pressure on prices, the Russian invasion of Ukraine led to spikes in energy and food prices. Most central banks were forced to raise policy rates sharply to bring inflation back under control and keep long-term inflation expectations anchored. The Federal Reserve initiated the steepest interest rate cycle (the largest rate hike in the shortest time). It resulted in the worst year ever for bond markets.
While during November bond yields eased somewhat thanks to better inflation data, they went sharply higher again in December due to central banks' hawkish stance. German 10-year yields jumped over 60 basis points higher in December to above 2.5% which was just slightly higher than the October high. US 10-year rates rose less sharply by 30 basis points and at 3.87% remained well below October's level.
After their sharp fall in November, spreads of both investment grade and high yield corporate bonds in Europe went a little lower in December. However, they are still at levels well above those at the start of 2022.
Central banks: ECB and Bank of Japan deliver a surprise
The European Central Bank raised deposit rates from 1.5% to 2.0% in December, as widely expected. But the message that policymakers intend to raise interest rates "significantly further" was more hawkish than expected. In addition, it was announced that the central bank will start unwinding its bond portfolio (within the framework of the Asset Purchase Programme) from March 2023, by an average of €15 billion a month. This is considered a very moderate pace.
After four consecutive 75-basis-point hikes, the Federal Reserve raised its policy rate by 50 basis points last month as expected. Chairman Jerome Powell's comments remain quite strict: he stated that the FOMC still needs "significantly more evidence" before they can be sure that inflation is falling. He reiterated to expect several more interest rate hikes. Fed members further revised upwards their interest rate projections (the so-called dot plots) based on a higher expectation for core inflation in 2023. The Fed members' median estimate for the peak of interest rates this year now stands at 5.1%, which is higher than market expectations.
Japan's central bank also provided a surprise. It unexpectedly widened the margin of tolerance from 0.25% to 0.50% around its yield target of 0%. The policy rate remained unchanged. The easing of the Yield Curve Control Target may signal that the Bank of Japan will gradually abandon the YCC, but is probably not the harbinger of higher policy rates.
|Fed funds||4.25-4.5%||+0.50%||Dec. 2022|
|ECB deposit rate||2.0%||+0.50%||Dec. 2022|
Currencies: Hawkish ECB pushes euro higher
Over the past month, in addition to the Federal Reserve, the ECB and the Bank of Japan, numerous other central banks (in the UK, Switzerland, Norway,...) were at it again. The ECB's restrictive comments caused the market to significantly revise upwards its expectations for peak policy rates to above 3%, well above what had already been priced in. This resulted in the euro strengthening against most other currencies. For instance, the dollar weakened by almost 3% against the euro in December, but still remains 5.8% higher than at the start of 2022. The Japanese yen did manage to strengthen against the euro following the Japanese central bank's decision.
The Chinese currency strengthened against the US currency and is again trading below 7 renminbi per dollar. The market is looking ahead to later this year when the Chinese economy will experience a recovery after the current covid wave, while the US economy may be heading for a recession. This is already resulting in a narrowing interest rate differential on long-term bonds of both countries to the detriment of the dollar.
Commodities: Growing fears of recession weigh on prices
Volatility was the hallmark of the commodities market, which in 2022 was caught between geopolitical tensions and rising recession fears. December was no different. After the sharp fall in November, Brent oil prices remained fairly stable on balance (in dollar terms). The market fears that rising recession risks will dampen demand. Moreover, the introduction of a price cap by the G7 countries on Russia's offshore oil exports did not lead to a price increase. European natural gas prices fell sharply, to 70 Eur/MWh, the lowest level since Russia's invasion of Ukraine. The EU finally agreed on a ceiling (180 Eur/MWh) for Russian gas. The impact is likely to be limited given the high level of the cap and the conditions before it takes effect. Milder weather and a seasonal drop in industrial demand have driven the price drop at a time when storage levels are relatively high.
Industrial metals were fairly stable in December, yet went lower over the whole of 2022 despite the sharp rebound during the first few months of the year. China's reopening (as a major consumer of industrial commodities) was supportive in December, but the global growth slowdown counterbalanced it.
Gold prices firmed in December, closing the year virtually unchanged (in dollar terms). However, the interest rate environment remained unfavorable for gold over the past month. The weakening dollar and likely purchases by non-Western central banks (China, Russia,...) diversifying their reserves away from the dollar were, besides high geopolitical risks, the supporting factors.