April 2023 / QUARTERLY MARKET REVIEW
Global Markets Quarterly Update
For First Quarter 2023
- Global equity and bond markets generally performed well in the quarter, boosted in part by China’s quick reopening following the end of strict COVID lockdowns.
- Banking turmoil in the U.S. and Europe in March weighed on financials stocks but helped growth stocks by lowering interest rate expectations.
- Inflation remained above target but cooled in most economies, with the notable exception of the UK, while growth was weak but generally surprised on the upside.
Stocks managed a second consecutive quarter of overall gains, but the performance of individual sectors and benchmarks varied markedly. Turmoil in the banking sector and signs of ebbing growth and inflation pressures led to lower Treasury yields and boosted growth shares by increasing the implied value of future earnings. The Nasdaq Composite Index jumped 16.77% on a principal basis, and technology shares within the S&P 500 Index returned 21.82%, including dividends. Conversely, sharp declines in regional banking stocks and oil prices contributed to declines in smaller-cap value shares.
Dramatic Moves in U.S. Treasury Yields
A “flight to safety” following the banking turmoil led to a sharp decrease in U.S. Treasury yields and provided a general lift to bond prices. The move in the two‑year yield was the most dramatic, falling 130 basis points (1.30 percentage points) from its high on March 8 to a low of 3.77% on March 23. The yield curve stayed inverted, however, with the two year yield remaining well above the 10-year yield. Yield curve inversions have typically, but not uniformly, served as an indicator of a coming recession.
Favorable inflation data helped stocks start the quarter on a strong note. Headline consumer prices ticked lower in December, bringing the year-on‑year increase to 6.5%—still well above the Federal Reserve’s long-term 2% inflation target but the slowest pace since October 2021. Producer prices fell 0.5% in December, the biggest drop since early in the pandemic, raising hopes that further retail price cuts were in the pipeline. December retail sales fell sharply, and a gauge of services sector activity surprised observers by falling into contractionary territory, joining the already shrinking manufacturing sector.
Inflation Fears Nearly Wipe Out Quarter’s Gains by Early March
However, February brought evidence that consumers had only postponed their shopping until January—perhaps waiting for post‑holiday sales—and that inflation had reaccelerated after several months of declines. Personal spending rose a solid 1.8% in January, the biggest increase in nearly two years, while retail sales jumped 3.0%, the biggest increase in 10 months. Meanwhile, the Commerce Department’s core (excluding food and energy) personal consumption expenditures (PCE) price index jumped 0.6% in January, its biggest month-over‑month rise since August. December’s figure was also revised higher, pushing the yearover‑year increase—widely considered to be the Federal Reserve’s preferred inflation gauge—from 4.6% to 4.7%, the first pickup since September.
The collapse of two major regional banks in mid-March sent financials sharply lower, but a plunge in bond yields boosted growth shares. Following a run on its deposits, Silicon Valley Bank (SVB) fell into FDIC receivership, followed that weekend by New York‑based Signature Bank. Reports of stressed balance sheets at other regional banks fed concerns that problems in the industry—a key source of financing for commercial real estate and other smaller-size businesses— would result in a severe tightening in credit conditions.
Fed Acknowledges Banking Turmoil Has Tightened Credit Conditions
Working with other regulators, the Fed appeared to successfully stem the regional bank outflows, at least for the time being. More importantly for the broader market, Fed officials increased rates by a quarter point at their March 22 policy meeting but acknowledged that tighter credit conditions might lessen the need for further hikes. Contrary to the professed outlook of Fed officials, markets also began pricing in rate cuts by the end of the year. Gains in some mega-cap technology and internet‑related shares in particular helped feed a broader rally.
Some reassuring inflation signals may have also fed the rally to end the quarter. The February PCE price index fell back to 4.6% versus consensus expectations for 4.7%. Personal spending rose less than expected during the month, and the University of Michigan’s gauge of consumers’ inflation expectations over the following 12 months fell to 3.6%, below expectations and its lowest level in nearly two years. Consumers appeared to be encouraged in part by falling gasoline prices, with domestic oil prices dropping to their lowest level since late 2021.
The STOXX Europe 600 Index posted strong gains in the quarter, buoyed by better-than-expected economic data and hopes that interest rates could be close to peaking. However, the advance was curbed by bank failures in the U.S. and Europe that roiled the financial system in March. Major equity indexes in France, Germany, Italy, and the UK also climbed.
Bank Stocks Roiled by Financial System Worries
Banking stocks in the STOXX Europe 600 Index fell sharply at the end of the quarter, eroding most of the strong gains posted by the industry earlier in the year. The failure of two regional lenders in the U.S. reverberated across the global financial system, while concerns about the health of Credit Suisse and fears of counterparty risk also pressured bank shares. The market steadied after the Swiss National Bank provided the embattled financial giant with a loan of roughly USD 50 billion and on news that UBS Group would take over the group in a government-brokered deal. However, concerns that other problems may be lurking in the financial system weighed on some banks.
ECB Sticks to Half-Point Rate Hike; Inflation to Stay Above Target
The European Central Bank (ECB) raised its deposit rate by a half percentage point over the quarter to 3.0% to curb elevated inflation. The central bank reiterated that future decisions would be data dependent but gave no forward guidance. The ECB added that it is monitoring current market tensions closely and that “the euro area banking sector is resilient, with strong capital and liquidity positions.”
The ECB’s macroeconomic projections put average inflation at 5.3% in 2023 and 2.1% in 2025, while the economic forecast called for a 1.0% expansion this year and 1.6% growth in 2024 and 2025. The annual rate of consumer price growth slowed to 6.9% in March from 8.5% in February, as energy costs receded.
BoE Hikes Interest Rates After Surprise Surge in Inflation
The Bank of England (BoE) raised interest rates to 4.25% from 3.50%, marking 11 consecutive increases. Financial markets appeared to expect another rate increase in May, as inflation accelerated to 10.4% in February.
Minutes from the meeting showed that the Financial Policy Committee told policymakers before the vote that the “UK banking system maintains robust capital and strong liquidity positions,” and “that the UK banking system remains resilient.”
Revised data showed that gross domestic product in the fourth quarter grew 0.1% sequentially, instead of being flat, and shrank by only 0.1% in the previous three months—less than the 0.2% contraction initially estimated.
Pension Reforms Ignite French Protests
France was rocked by a series of large‑scale and often violent nationwide demonstrations against pension reforms that would raise the retirement age to 64, an increase of two years. President Emmanuel Macron exercised special constitutional powers to enact the changes without a vote in Parliament.
Japanese equities gained over the first quarter, with the MSCI Japan Index up 7.30% in local currency terms. Sentiment was supported by the prospect of China’s reopening boosting the global economy and hopes that the major central banks would slow the pace of their rate hikes. Speculation about the Bank of Japan’s (BoJ’s) future monetary policy trajectory continued as it was announced that surprise nominee Kazuo Ueda was set to become the next BoJ Governor in April. Gains were capped by the turmoil in the global banking sector in March, which weighed on risk appetite despite the limited direct impact on Japan’s financial system.
Against this backdrop, the yield on the 10‑year Japanese government bond (JGB) briefly fell to 0.20% in March, as investors sought out assets perceived as safer. It finished the quarter at 0.32%, down from 0.42% at the end of December. The yen weakened, to around JPY 132.8 against the U.S. dollar, from about 131.1 the prior quarter. This masked the Japanese currency’s strength in March on the flight-to-safety trade.
BoJ Leaves Monetary Policy Unchanged at Kuroda’s Last Meeting
The BoJ made no changes to its monetary policy in March at the final meeting chaired by outgoing Governor Haruhiko Kuroda, who steps down in April. The central bank kept its key short-term interest rate at -0.1% and reiterated its 0% target for 10-year JGB yields. It will also continue its large-scale bond-buying in the conduct of yield curve control (YCC), whereby 10-year JGB yields are allowed to fluctuate in the range of half a percentage point from the target level.
Investors’ focus now turns to the BoJ’s April meeting, which will be the first under incoming Governor Kazuo Ueda. Ueda has hinted at various possibilities for the future of the BoJ’s YCC framework, while emphasizing that the outlook for underlying prices will determine whether it is reviewed in the direction of normalization. There is some speculation that the BoJ could widen further the range in which JGB yields are allowed to fluctuate or abandon the framework altogether.
Japan’s Inflation Remains High, but Price Pressures Ease
On the economic data front, the rate of consumer inflation slowed in Japan, with the core consumer price index rising 3.1% year on year in February, down from January’s 4.2%, an over‑four‑decade high. The contribution from energy fell notably due to government electricity subsidies to cushion the impact of price pressures. Economic growth over the final quarter of 2022 was revised down to 0.1% annualized, from 0.6% in the preliminary estimate.
Large Companies Agree on Biggest Wage Increases in Decades
Japan’s annual “shunto” spring wage negotiations, held between businesses, major industrial unions, and government leaders, wrapped up in March. Many large Japanese companies, including some leading equipment manufacturers and automakers, agreed to the biggest wage increases in decades—according to initial data, the base-pay rise was strong at 2.3%, ahead of economists’ consensus expectations of around 1.5%.
Chinese equities advanced as signs of economic momentum and expectations that Beijing would maintain its accommodative stance boosted sentiment. The MSCI China Index climbed 4.7% and the China A Onshore Index gained 6.07%, both in U.S. dollar terms.
In January, China reported that its gross domestic product rose 3% in 2022, marking one of the country’s slowest growth rates in decades and missing the official target of around 5.5% set a year ago. Still, the reading surpassed most economists’ forecasts after Beijing abandoned its stringent pandemic restrictions in December. In March, officials set an economic growth target of around 5% this year at the annual National People’s Congress, China’s parliament, a goal that economists regarded as conservative.
Premier Li Qiang, the country’s second‑ranking official, reinforced China’s commitment to open its economy and deliver reforms that can stimulate consumption and international business. Speaking at the Boao Forum for Asia in March, Li pledged that China’s recovery would deliver momentum to the world economy despite challenges in the geopolitical environment.
China’s parliament approved a plan for an overhaul of central government institutions under the State Council, the country’s cabinet. The changes marked the biggest bureaucratic restructuring in years and come as China seeks to accelerate the development of critical technologies to reduce its reliance on foreign technology.
On the monetary policy front, the People’s Bank of China left its benchmark one-year and five-year loan prime rates unchanged in March for the seventh consecutive month. Analysts expected the move after the central bank earlier left its medium-term lending facility unchanged and unexpectedly announced a 25-basis-point cut in the reserve requirement ratio for most banks.
China’s consumer price index rose a lower-than-forecast 1% in February from a year earlier, down from a 2.1% rise in January. Producer prices also fell over the quarter due to lower commodity costs. The official manufacturing purchasing managers’ index (PMI) rose to a better-than-expected 51.9 in March, while the nonmanufacturing PMI increased to 58.2, the highest reading since May 2011. The mixed results signaled a muted recovery in China and raised expectations that policymakers would maintain accommodative policies.
Turkish Stocks Struggle Following Earthquake
Stocks in Turkey, as measured by MSCI, returned -9.23% versus 4.02% for the MSCI Emerging Markets Index.
A massive earthquake with a magnitude of 7.8 on the Richter scale struck in the early morning hours of February 6 near the border between Turkey and Syria. As losses in terms of human life mounted, and as the extent of infrastructure damage became clearer, President Recep Tayyip Erdogan announced a week of mourning and requested international assistance. He also declared a three-month emergency in 10 provinces, and the stock market suspended trading for several days following a steep sell-off.
Later in February, the central bank decided to reduce its key interest rate— the one-week repo auction rate—from 9.00% to 8.50%. While officials felt that the earthquake “will not have a permanent impact on performance of the Turkish economy in the medium term,” they concluded that it has become “even more important to keep financial conditions supportive.
Despite the disruptions and population displacements caused by the earthquake, Erdogan officially called for presidential and general elections to take place on May 14. The opposition, which is a six-party bloc known as the National Alliance, nominated Kemal Kilicdaroglu as the joint presidential candidate. The National Alliance also unveiled a road map to governance in which there will be a power-sharing mechanism between the presidency and constituent parties, where major decisions and appointments to top civil service posts will be taken in consultation.
T. Rowe Price sovereign analyst Peter Botoucharov believes that the February earthquake has increased the unpredictability of the electoral outcome. However, more recent political developments—including the opposition bloc announcing a single presidential candidate, who is also likely to be supported by the pro-Kurdish HDP party—increase the probability of the opposition winning at least one of the upcoming presidential and general elections.
Brazilian Equities Decline After Political Transition
Brazilian stocks, as measured by MSCI, returned -3.09% in U.S. dollar terms and -6.94% in local terms in the first quarter and trailed the MSCI Emerging Markets Index.
On January 1, Luiz Inácio Lula da Silva (Lula) took office as president. Just one week later—in a scene reminiscent of the U.S. Capitol riot two years earlier— Bolsonaro’s supporters broke through security lines at a demonstration in Brasilia and temporarily invaded Congress, the supreme court, and the president’s office, seemingly demonstrating the opposition that Lula is facing from a sizable portion of the population.
Throughout the quarter, Lula and some members of his administration made public complaints about the central bank’s tight monetary stance: the year‑over‑year inflation rate is currently close to 6%—well below the highs reached in the first half of 2022—but the Selic rate has remained at 13.75%. Finance Minister Fernando Haddad has argued that high borrowing costs are the main hindrance to stronger economic growth. Central bank president Roberto Campos Neto has largely refrained from responding to criticism in public, while maintaining a strong defense of the central bank’s autonomy and technocratic monetary policy.
Major Index Returns
Total returns unless noted
|U.S. Equity Indexes|
|Dow Jones Industrial Average||0.93|
|Nasdaq Composite (Principal Return)||16.77|
|Global/International Equity Indexes|
|MSCI Emerging Markets||4.02|
|MSCI All Country World||7.44|
|Bloomberg U.S. Aggregate Bond||2.96|
|Bloomberg Global Aggregate Ex‑USD||3.06|
|Credit Suisse High Yield||3.90|
|J.P. Morgan Emerging Markets Bond Global||2.25|
What We're Watching Next
Sébastien Page, CIO, Head of Global Multi-Asset
Given the speed of events, trying to summarize the impact of the turmoil in the banking sector is like trying to hit the proverbial moving target. But one thing seems clear: This is another headwind facing the economy.
Financial conditions have already moved to their tightest level since the onset of the pandemic, and it could get worse. We haven’t borne the brunt of the full effects of the 475 basis points (bps) in rate hikes the Fed has made since last March, and several signs suggest that the Fed has already slowed the economy considerably.
To be sure, financial strains mean a more dovish Fed, all things considered. As policymakers have acknowledged, reduced liquidity and slowed growth in the wake of the banking stresses will do some of the work in cooling inflation that otherwise would be done by rate hikes. But that doesn’t mean that the Fed will necessarily begin lowering or even stop raising rates from here.
It’s likely that policymakers will follow their European counterparts in using targeted measures to ease further signs of stress as they appear. For example, the European Central Bank kept on its planned path of rate hikes last summer but communicated a backstop to stressed Italian sovereign debt. Several months later, the Bank of England kept raising rates even as it headed off a crisis in its pension system by buying the government’s long-term bonds (gilts).
It’s unlikely that we face a systemic meltdown, such as the banking crisis that began in 2008. I see several key differences:
- We do not appear to be in a recession. The economy had been in one for nine months before the collapse of Lehman Brothers in September 2008. We’re currently near full employment, and families and businesses are still sitting on ample cash—if not quite as much as before.
- Banks are better regulated and better capitalized than they were in 2008, with more cash on hand and stronger capital ratios.
- There’s much less speculation on bad housing loans with derivatives layered on top of them. In fact, mortgage delinquencies are near historical lows.
- This time, banks are dealing with mostly paper losses due to Fed tightening. It’s easier to reverse rates and remove the balance sheet pressure this time around, while in 2008, banks were dealing with irreversible credit losses.
- Following the banking reforms in 2010, there’s much more transparency and much less speculation in unregulated and complex areas of financial markets.
A colleague of mine is calling this a “Black Duck” event, in contrast to the “Black Swan” of 2008. Black ducks are more common than black swans—you see them around occasionally and don’t bother pulling out your camera.
In other words, while investors shouldn’t panic, they may consider lowering their growth and earnings expectations.
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