Global Markets Weekly Update

Stocks recorded their third consecutive week of broad losses, as concerns over tensions in the Middle East and the possibility of U.S. interest rates remaining “higher for longer” appeared to weigh on sentiment. Mega-cap technology shares lagged as rising rates placed a higher theoretical discount on future earnings. A first-quarter revenue miss from advanced chipmaker supplier ASML Holdings also seemed to weigh on the sector and on general optimism toward companies with artificial intelligence (AI)-related earnings, according to T. Rowe Price traders. Small-caps continued to struggle, pushing the small-cap Russell 2000 Index further into negative territory for the year-to-date period.

The trading week started off on a strong note, which our traders believed to be driven by relief that Iran’s well-telegraphed retaliatory strike on Israel did not result in worst-case scenarios, with nearly all missiles fired into the country intercepted by air defenses. However, hopes that Israel would carry out a measured response faded alongside stock prices as reports surfaced that the Israeli war cabinet had decided to retaliate “clearly and forcefully.” On Friday, stocks headed lower again, after Israel conducted strikes on air defense facilities within Iran, as well as on Iran-backed groups in Iran and Iraq (see below).

Some strong economic data appeared to increase worries that the Federal Reserve would push back any interest rates cuts to the fall, if not to 2025. On Monday, the Commerce Department reported that retail sales rose 0.7% in March, well above consensus expectations of around 0.3%, while February’s gain was revised upward to 0.9%. Rising gas prices were partly at work (the data are not adjusted for inflation), but the strength was broad-based and included healthy gains in discretionary categories, such as restaurants and bars and online retailers.

Conversely, downward surprises in housing market data may have furthered inflation fears by auguring continued supply tightness. Housing starts and permits in March came in well below expectations and declined from February, with the former falling to the lowest level in seven months. Existing home sales also declined, although largely in line with expectations, as the average 30-year mortgage rate climbed above 7% for the first time since December.

As was the case the previous week, Fed officials expressed their concern with recent economic data. On Tuesday, Fed Chair Jerome Powell stated at an economic conference that “recent data have clearly not given us greater confidence and instead indicate that it’s likely to take longer than expected to achieve that confidence.” On Thursday, New York Fed President John Williams warned that a rate hike is not the baseline, but that one is possible if the data warrants. Atlanta Fed President Raphael Bostic said that policymakers would not be in a position to cut rates until the end of the year.

The retail sales data helped push the yield on the benchmark 10-year U.S. Treasury note to its highest intraday level since early November. (Bond prices and yields move in opposite directions.) Municipal bond yields also increased in the first half of the week alongside a flood of new issuance, but they held in well relative to Treasuries later in the week as most of the new deals were met with strong demand.

In the investment-grade corporate bond market, issuance was relatively light but met expectations, and most issues were oversubscribed. However, the higher-for-longer rates narrative and geopolitical tensions weighed on the high yield bond market, and our traders noted that trade volumes were somewhat above average as more sellers appeared to be active and high yield funds industrywide reported negative flows.

In local currency terms, the pan-European STOXX Europe 600 Index ended 1.18% lower as tensions rose in the Middle East. Major stock indexes were mixed: Germany’s DAX fell 1.08%, Italy’s FTSE MIB gained 0.47%, and France’s CAC 40 Index was little changed. The UK’s FTSE 100 Index declined 1.25%. European government bond yields broadly climbed.

Consumer prices in the UK grew an annual 3.2% in March, down from 3.4% in February. Although the inflation rate fell to its lowest level in two and a half years, the decline was slightly less than forecast by analysts and the Bank of England (BoE) due to elevated price growth in fuel and communication goods. Services inflation—a measure of underlying price pressures that is watched closely by the BoE—remained high but slowed to 6.0% from 6.1%.

Wage growth also slowed less than expected in the three months through February. Excluding bonuses, pay increased 6% year over year, down from 6.1% in the preceding period. The unemployment rate rose sharply to 4.2% in February from 3.9%. Job vacancies continued to decline in the first quarter.

Higher oil prices and the somewhat sticky inflation data prompted financial markets to push out expectations for a first cut in UK interest rates from June to sometime in the fall. In contrast, BoE Governor David Bailey sounded more upbeat. “In the UK, we're disinflating at what I call full employment,” he said at the International Monetary Fund’s (IMF) annual meeting. “I see, you know, strong evidence now that that process is working its way through.”

A slew of European Central Bank (ECB) policymakers at the IMF meeting reiterated that June was the likely target date for lowering borrowing costs, barring unexpected economic shocks. ECB President Christine Lagarde declined to say whether there might be more than one reduction in rates. In an interview with CNBC, she argued that policy should still depend on incoming economic data, given high levels of uncertainty. She added that the ECB would monitor oil prices “very closely” amid worries about conflict in the Middle East. In an interview with Bloomberg, Governing Council member Martins Kazaks also highlighted the uncertainty but added that the three to four rate cuts this year priced in by markets were in line with the bank’s economic outlook. 

Amid an escalation in tensions in the Middle East, Japan’s stock markets suffered sizable losses over the week. The Nikkei 225 Index was down 6.2%, and the broader TOPIX Index lost 4.8%. An additional factor weighing on the markets was some concern about waning AI-related demand.

In fixed income, the yield on the 10-year Japanese government bond closed the week at around 0.84%, broadly unchanged from the prior week. Bank of Japan Governor Kazuo Ueda echoed previous comments in stating that, if weakness in the yen exerts significant upward pressure on inflation, a rate hike may be warranted.

In the foreign exchange markets, the yen, perceived as a safe-haven currency especially in times of geopolitical turmoil, strengthened on the final trading day of the week. It nevertheless continued to hover around 34-year lows and finished the period in the mid-JPY 154 against the U.S. dollar range, from the low-JPY153 range at the end of the previous week.

While speculation continued about Japanese authorities potentially intervening in the currency markets to prop up the yen, no such move was forthcoming. However, U.S., Japanese, and South Korean leaders met to discuss current conditions in the foreign exchange markets, focusing on the recent sharp depreciation of the Japanese yen and the South Korean won.

Japan’s exports rose 7.3% year on year in March, slightly slower than the 7.8% gain registered in February. The data print nevertheless marked the fourth consecutive month of growth in exports, attributable to the boost provided to Japan’s exporters by historic weakness in the yen. Signs of a pickup in Chinese demand also lent support.

In other economic data releases, the core consumer price index (CPI), a leading indicator of nationwide trends, was 2.6% higher year on year in March, slightly lower than had been expected and down from a revised 2.8% in February. While suggesting that price pressures could be easing somewhat, data showing that Japan’s inbound tourism grew solidly in March, driven by an increase in visitors from South Korea and China, is likely to support services inflation.

Chinese equities rose after the economy expanded more than expected in the first quarter. The Shanghai Composite Index gained 1.52%, while the blue chip CSI 300 added 1.89%. In Hong Kong, the benchmark Hang Seng Index gave up 2.89% as escalating geopolitical tensions in the Middle East hurt investor sentiment.

China’s gross domestic product expanded an above-consensus 5.3% in the first quarter from a year ago, accelerating slightly from the 5.2% growth in last year’s fourth quarter. On a quarterly basis, the economy grew 1.6%, rising from the fourth quarter’s 1.4% expansion.

However, other data provided a mixed snapshot of the economy. Industrial production rose a lower-than-expected 4.5% in March from a year earlier, down from 7% growth in the January to February period. March retail sales grew a lower-than-expected 3.1% from a year ago as catering and auto revenue slowed after the Lunar New Year Holiday. Meanwhile, fixed asset investment rose more than forecast in the first quarter from a year ago, although property investment fell 9.5% year on year. The urban unemployment rate eased slightly to 5.2%, while the youth jobless rate stayed at 15.3% in March, unchanged from February.

On the monetary policy front, the People’s Bank of China injected RMB 100 billion into the banking system via its medium-term lending facility compared with RMB 170 billion in maturing loans and left the lending rate unchanged, as expected. The operation resulted in a net withdrawal of RMB 70 billion from the banking system, marking the second cash extraction this year.

China’s new home prices fell 0.3% in March, matching February’s 0.3% drop and extending losses for the ninth consecutive month, according to the statistics bureau. Authorities have ramped up efforts to revive the troubled sector by relaxing homebuying restrictions and directing state-owned banks to step up lending to indebted property developers. However, analysts said the data showed that China's housing slump has not yet bottomed and remains a significant drag on the economy.

Over the previous weekend, Iran launched a wave of 300 drones and missiles at Israel, nearly all of which were shot down before entering Israeli airspace with the help of British, American, and Jordanian air forces.

According to T. Rowe Price credit analysts Razan Nasser and Peter Botoucharov, this attack marks a significant escalation in tensions between Israel and Iran, as this is the first time that Iran launched a direct attack on Israel rather than using its proxies. The Iranian attack came in response to an Israeli strike on a diplomatic facility in Damascus, which led to the killing of several senior Iranian Revolutionary Guard members. Iran viewed the Damascus strike as a hit to its sovereign territory and vowed to respond. They felt the need to reestablish deterrence as well as play to domestic pressures to look strong. The attack, however, was telegraphed well in advance and didn’t use advanced weapons. In a letter to the United Nations, Iran said that it now considers this matter over and will not conduct another strike unless Israel choses to retaliate.

Early Friday morning local time, Israel carried out a reprisal strike on an Iranian airbase in the city of Isfahan. The attack appears to be limited in nature—at least according to Israeli and local Iranian news—and both sides have downplayed the retaliation, indicating little or no damage. T. Rowe Price analysts believe that this week’s attacks seem to be signaling actions about Iranian and Israeli military capabilities rather than an attempt to escalate the situation.

On Tuesday, Türkiye’s central bank governor, Fatih Karahan, spoke at a Council on Foreign Relations event focusing on central bank governance in emerging markets. As reported by Bloomberg, Karahan—facing the choice between rebuilding Türkiye’s foreign exchange reserves and fighting inflation—has decidedly favored the latter. She was quoted as saying, “Our…utmost priority is disinflation, and we will accumulate reserves as much as we can, depending on market conditions.”

On Wednesday, in response to journalists’ questions, Turkish Labor Minister Vedat Isikhan said that the government does not intend to raise the minimum wage in July. This is a reversal from his stance back in January, when he pushed for a higher-than-expected minimum wage hike, against Minister of Treasury and Finance Mehmet Simsek’s recommendation. According to T. Rowe Price portfolio manager and credit analyst Ulle Adamson, the proliferation of this message over time should help set disinflation expectations throughout Turkish society. She believes that another minimum wage hike in July would have nullified any chance of inflation approaching the central bank’s inflation target by the end of the year.