October has form as a bad month for markets; most famously the Great Crash of 1929, Black Monday in 1987, and the banking crisis in 2008. While October 2023 wasn’t so catastrophic, bonds and stocks fell sharply as yields jumped and the violence in the Middle East rattled market sentiment. Commodities were the only bright spot, as oil prices surged on supply disruption and investors fled to gold as a safe haven.
The IMF downgraded the UK’s growth forecasts for 2023 and 2024 due to persistently high inflation. The latest CPI rating showed inflation unchanged at 6.7% – lower than its peak but still triple the Bank of England’s target. High petrol and hotel prices offset a drop in food prices.
In Edinburgh, the devolved government stated its intention to issue its own bonds for the first time. The Scottish bonds would be backed by the UK Treasury but would likely trade at a higher yield due to lower liquidity and the risks associated with potential independence. Normal UK government bonds are called gilts; inevitably, traders nicknamed the proposed Scottish bonds “kilts”.
The benchmark US 10-year Treasury yield pushed above 5% for the first time since 2007, driven by red-hot economic data and concerns around the unsustainability of government finances. Real GDP growth ramped up to an annualised pace of 4.9% in the third quarter – or a blistering 8.5% in nominal terms – fuelled by higher consumer spending and companies restocking inventories. Meanwhile the government deficit is on track to exceed 8% of GDP this year, with no signs of a return fiscal sanity for the rest of the decade.
Europe’s economy is struggling in the face of rate hikes. Goldman Sachs says higher yields have “exposed a fault line in European sovereign credit”, with Italy as the focal point. The Italian government is loosening fiscal policy and preparing to roll over old debt equalling 24% of GDP this year, and to do so at rocketing borrowing costs. Risk spreads on Italian 10-year bonds (the gap versus their German counterparts) have spiked to 207 basis points and are now in the amber warning zone.
Chinese stocks fell to their lowest level since 2019, as Beijing’s stimulus measures failed to stem a sell-off driven by slowing economic growth and a liquidity crisis in the property sector. Short-term lending rates hit 50% in late October before the central bank intervened, and figures show Chinese developers have already defaulted on three-fifths of their entire liabilities of $175bn. Battling to stay out of the so-called middle income trap, there are signs that Beijing will try to ease US-China trade tensions ahead of Xi Jinping meeting Joe Biden in San Francisco this month.
Emerging Market stocks dropped as investors adopted a risk-off attitude in the wake of the attack in Israel. Middle Eastern stock markets were especially impacted, while Turkey was the worst performer as inflation hit 60%. Brazil and India outperformed.
The Bank of Japan kept interest rate unchanged, but adjusted its yield curve control policy, letting 10-year bond yields rise above 1.0% by declaring that level to be a “reference” rather than a limit. Meanwhile it was earnings season for corporate Japan, with lukewarm figures from the big exporters but resilient growth from domestic consumer companies.
Overall it was an ugly month for investors, with stock and bond declines across the board. Red-hot US economic growth is small comfort when it merely fuels the “higher for longer” interest rate mantra. Going forward, we expect US growth to slow as higher rates bite and the government exhausts deficit spending. The re-pricing in bonds leaves the asset class ready to do its job as a diversifier in the event of a deflationary recession. In the meantime the positive correlation between stocks and bonds is a reminder of the importance of alternative assets, such as commodities, to hedge against other risks.