Monthly Wrap: March 2023

Bank trouble vs inflation fight

Major central banks remained resolute in their determination to fight inflation despite the rescue of two banks in the US and the systemically important bank, Credit Suisse. The banking turmoil caused by the collapse of Silicon Valley Bank (SVB) put the Federal Reserve (Fed) in a tough spot. Rate expectations were very volatile leading up to the March Fed meeting. Unfortunately, data released beforehand offered few unambiguous signs. If anything, it pointed to still elevated inflation. 

An increase in February in non-farm payrolls, together with low and steady initial jobless claims, confirmed a tight labour market. February headline consumer price index (CPI) trended lower as energy prices fell, rose a modest 0.4%. However, core CPI increased 0.5%, driven by the continuing rise in core services, with details suggesting even stronger inflation. 

Later in the month, personal consumption expenditures (PCE) data echoed a similar trend. Both headline and core PCE eased in February, falling below consensus. However, factors like rising personal income and rebounding airfares imply the slowdown may not sustain. Additionally, core PCE inflation remained over double the Fed’s target, signifying persistent inflation.

Ultimately, on 22 March, the FOMC increased rates by 25bps to a 4.75-5.0% range and softened language about possible future hikes. 

The Fed’s March economic projections had minimal changes compared to December, though underlying reasoning may have shifted. The 2023 dots remained at 5-5.25%, hinting at one more potential rate hike. 

Despite current uncertainty around the impact of credit tightening from banking sector instability on activity and inflation, the next few months will likely show persistently strong inflation data. This could make it challenging for the Fed to implement rate cuts that are now priced into markets.

Source: Federal Reserve website 

Banking stresses also emerged in Europe, which settled upon the merger of UBS and Credit Suisse. Despite some calls to delay further monetary policy tightening, the European Central Bank (ECB) raised interest rates by 50bps on 16 March, sticking with its fight against inflation.

EU inflation continues to be marked by a disparity between the headline and core measures. While headline inflation declined from 8.5% to 6.9% YoY due to lower energy prices, the core inflation rose to a record high of 5.7%, of which services inflation increased from 4.8% to 5% and food inflation increased from 15% to 15.4%. Though the decline in energy prices indicated a possible peak in core inflation over the near term.

Despite the lingering uncertainty in financial markets, the persistent high core inflation suggests that ECB may continue tightening. 

Implications for Australia?

On 7 March, the Reserve Bank of Australia (RBA) increased the cash rate by 25bps, while striving to balance economic growth and inflation. February CPI data revealed that inflation had moderated more than expected, easing from 7.4% to 6.8% YoY. While core inflation remained relatively persistent, the RBA left the door open to a potential rate pause. The RBA flagged declines in clothing and footwear, household furnishing, equipment and services costs as evidence that inflation has peaked. 

China’s strong productivity drives the shift to economic development 

China’s post-covid recovery is progressing well, despite external financial and demand uncertainties. This is demonstrated by accelerated domestic expansion, as indicated by surge in manufacturing and non-manufacturing purchasing managers’ indexes. With the new economic team officially in place, the policy approach is shifting from risk management to economic development, with a renewed emphasis on real business. 

Overall, the recently released 2023 GDP growth target of 5% from the current National People’s Congress appears to be within reach.

Historic bond market volatility

The bond market experienced elevated volatility in March, propelled by inflation, credit and liquidity concerns, as well as a sharp repricing of rate outlook. The MOVE index, which tracks bond market volatility, reached levels not seen since the global financial crisis.

In the US, the yield on the 10-year bond closed the month marginally lower at 3.49%. The 2-year bond yield, which is sensitive to policy changes and was above 5.0% early March, fell sharply by 73bps to 4.06%. Although the yield curve in the US remained inverted, the 2Y/10Y spread narrowed to -57bps from almost -100bps earlier in the month. Australian bonds are similar: the 2-year bond yield dropped by 70bps to 2.96% and the 10-year bond yield dropped by 56bps to 3.30%.

Equities demonstrate resilience

Despite a modest March, equity markets finished the quarter on a positive note, showing strong resilience. Global equity markets (MSCI World index) gained 3.2% for the month and Emerging markets (MSCI EM) returned 2.2%.

In March, the S&P 500 gained 3.7% while the NASDAQ rose 6.8%. European equities (Euro STOXX) had a strong year-to-date gain of 11.5% but returned a subdued 0.3% for the month. The ASX All Ordinaries was relatively flat, with a loss of 0.2%. In contrast, other Asia Pacific regions outperformed, led by a 3.5% rise in the Hang Seng and a 3.1% increase in Japan Nikkei.