U.S.

Wall Street breaks losing streak

Stocks broke a string of three weekly losses, as investors appeared to grow more confident that the market had reached at least a temporary bottom after surrendering about half of its summer rally. Some moderating inflation fears may have also been at work, and a midweek decline in oil prices—which briefly hit their lowest level since Russia’s invasion of Ukraine—caused energy shares to underperform within the S&P 500 Index, although the sector still recorded a gain. A rally in heavily weighted Tesla helped the consumer discretionary sector outperform. Markets were closed Monday in observance of Labor Day.

The market’s upturn began Wednesday, which T. Rowe Price traders largely attributed to a “relief rally” on light trading volumes. Federal Reserve Vice Chair Lael Brainard and Cleveland Fed President Loretta Mester also delivered comments that seemed to be more “dovish” than markets expected, with Brainard stating that she still believed the economy could avoid a recession as the Fed raised rates.

Hopeful inflation signals support sentiment

Our traders noted that signs that inflation was cooling quicker than expected also seemed to support sentiment. Stocks rallied after the Wednesday afternoon release of the Fed’s “Beige Book” summarizing economic reports from its branch banks. The report indicated that price increases were moderating in nine of its 12 districts, as “lower fuel prices and cooling overall demand alleviated cost pressures, especially freight shipping rates.” The report also noted some declines in prices for steel, lumber, and copper. A surprise moderation in Chinese producer price inflation (see below) seemed to help foster a rally on Friday.

The week’s light calendar of economic data brought what may have been confusingly mixed signals. On Tuesday, the Institute for Supply Management (ISM) and S&P Global released widely divergent final readings on August service sector activity, with the ISM gauge upwardly revised to 56.9, the fastest pace of expansion since April. However, the S&P Global measure fell more than expected, to 43.7, the biggest contraction since early 2020. (The number 50 marks the boundary between contraction and expansion for both indexes.) The ISM gauge is somewhat broader, including construction and other nonmanufacturing industries not in the S&P services measure. The labor market appeared to remain on solid footing, with weekly jobless claims coming in much lower than expected (222,000 versus roughly 240,000) and hitting their lowest level since the start of the summer.

Yields increase on large hike in European rates

The yield on the benchmark 10-year U.S. Treasury note jumped to its highest level since mid-June at the start of the trading week on Tuesday, which our traders attributed to anticipation of a large European Central Bank (ECB) interest rate increase on Thursday (see below) and heavier issuance of U.S. corporate bonds. (Bond prices and yields move in opposite directions.) The broad municipal bond market backtracked through most of the week amid continued outflows industrywide and upward pressure on interest rates. However, state general obligation deals from California and Pennsylvania were met with strong demand from investors.

The upward move in rates and an active primary calendar created a difficult environment for investment-grade corporate bonds early in the week, according to our traders. New issuance exceeded weekly expectations in what was ultimately a front-loaded week for the primary calendar. While the new issues were met with generally adequate demand, our traders noted some weakness when they reached the secondary market. However, as the level of primary issuance decreased, secondary trading volumes improved, and investment-grade corporates strengthened later in the week.

The U.S. high yield market advanced heading into Friday on a broad rebound in risk sentiment, while the bank loan market posted flat returns. Our traders noted that bank loan investors continued to focus on the new issue calendar as they digested commentary from Fed officials and awaited the release of key inflation data the following week.

U.S. Stocks

^{This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.
Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price's presentation thereof.}

Europe

Shares in Europe rose after some countries announced plans to deal with the energy crisis and boost their economies. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.06% higher. Major indexes also posted gains. Germany’s DAX Index rose 0.29%, France’s CAC 40 Index advanced 0.73%, and Italy’s FTSE MIB Index added 0.79%. The UK’s FTSE 100 Index increased 0.96%.

The British pound depreciated further against the U.S. dollar before retracing to roughly USD 1.16, a level near the low hit in 1985. This weakness appeared to stem, in part, from uncertainty about the economic agenda of new UK Prime Minister Liz Truss. The euro rose above parity with the U.S. dollar after the ECB hiked its key rates by a record amount.

ECB follows Fed with three-quarter-point rate hike

The ECB increased its key interest rates by a record 0.75 percentage point in a bid to curb inflation. The deposit rate now stands at 0.75%, while the refinancing rate sits at 1.25%—their highest levels since 2011. "This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target," the ECB explained in its official statement. Even so, the central bank indicated that more rate increases are likely. "Over the next several meetings the Governing Council expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations," the ECB added.

UK, Germany pledge large-scale support to cope with energy costs

Truss announced that the government would intervene to help reduce soaring energy costs for British households and businesses. The Financial Times reported that internal government estimates showed the size of the package could be around GBP 150 billion—bigger than bailouts during the COVID-19 crisis—and would be funded by government borrowing. In Germany, Chancellor Olaf Scholz said the government will spend EUR 65 billion to shield households and businesses, raising the monies from a tax on electricity companies and a planned corporate tax.

Separately, Finland, Sweden, Switzerland, and the UK pledged emergency liquidity support for electricity generators facing a potential cash flow crisis due to sharp increases in collateral required to hedge future production. European energy ministers are meeting to discuss intervention in the electricity market, with the main topics including price caps on electricity, potential price caps on Russian gas imports, windfall taxes, and efforts to improve energy efficiency.

BoE chief economist hints at further rate increases

Bank of England (BoE) Chief Economist Huw Pill hinted in testimony to Parliament that the government’s energy bailout plan could force the central bank to raise interest rates further. Asked by MPs whether the package would mean higher rates, Pill replied: “In response to the question, will fiscal policies generate inflation—we are here to ensure that they don’t generate inflation…Our remit is to get inflation back to target.” “We do have work to do,” he added.

Japan

Japan’s stock markets rose over the week, with the Nikkei 225 Index gaining 2.04% and the broader TOPIX Index up 1.83%. The government announced new measures to help Japan cope with rising inflation, while the yen fell to its lowest level in 24 years, prompting fresh comments from officials. The Japanese currency weakened to around JPY 142 against the U.S. dollar, from about JPY 140 the prior week. The 10-year Japanese government bond yield fell to 0.23%, from 0.24% at the end of the previous week.

New measures to help Japan cope with rising inflation

The government announced a new package, due in October, to help the country cope with rising inflation. The package includes cash handouts to low-income households as well as measures to keep some commodity and food prices at current levels. Prime Minister Fumio Kishida stated that it was the government’s priority to protect both households and businesses from the impact of higher import prices due largely to the war in Ukraine.

Yen falls to its lowest level in 24 years

The yen’s fall to its lowest level in 24 years prompted fresh comments from Japanese officials. Following a meeting with the prime minister, Bank of Japan (BoJ) Governor Haruhiko Kuroda said that the recent rapid moves in the currency were undesirable as they destabilize corporate business plans. While watching exchange rate moves carefully, the BoJ did not receive any specific policy requests from Kishida. Finance Minister Shun’ichi Suzuki stated, however, that the government did not rule out any options on foreign exchange moves.

Japan’s second-quarter economic growth upgraded

Gross domestic product expanded at an annualized rate of 3.5% in the second quarter, higher than the preliminary estimate of 2.2% growth. The economy was boosted by the lifting of coronavirus restrictions, which encouraged business spending and private consumption. While Japan’s economy has now regained its pre-pandemic size, there are some expectations that growth may slow due to the ongoing coronavirus pandemic, supply chain disruptions impeding production, rising prices, and global economic uncertainty.

Kishida emphasizes strong Japan-UK ties

Following the death of Queen Elizabeth II, Kishida paid his respects, stating that she had made a great contribution to strengthening the ties between Japan and the UK.

China

China’s stock markets rose as tame inflation data and expectations of further policy support prompted buying. The broad, capitalization-weighted Shanghai Composite Index advanced 2.4%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, added 1.7%, Reuters reported.

Inflation cools, but so does trade and domestic demand

China’s consumer and factory gate inflation in August declined from July’s levels and came in below analysts’ expectations. Consumer prices rose 2.5% over the 12 months ended in August, while factory gate prices rose 2.5%, down sharply from 4.2% the previous month. Year-over-year factory gate inflation (which excludes any transport or delivery charges) peaked at 13.5% in October 2021 and has trended consistently lower since. Earlier in the week, official data revealed that exports and imports lost momentum in August as surging inflation curbed overseas demand, while coronavirus restrictions and heatwaves disrupted China’s output.

On Friday, the People’s Bank of China (PBOC) set firmer-than-expected guidance for the yuan exchange rate against the U.S. dollar for the 13th straight trading day, a move viewed by analysts as part of the government’s efforts to slow the pace of the currency’s depreciation. Each trading day, China’s central bank releases a so-called daily fixing against the dollar, a reference rate for the onshore yuan that limits its moves by 2% in either direction. Analysts regard any significant discrepancy between the market’s expectations of the fixing and where the PBOC sets the midpoint as a policy signal of how Beijing wants to influence the currency. Last Friday, the yuan recorded its fourth weekly loss against the dollar, according to Reuters, and is down nearly 8% against the greenback this year as of the end of August.

Government tries to slow—but not reverse—yuan’s decline

Earlier in the week, China cut the amount of foreign exchange that domestic banks must hold in reserves,

a move seen as an effort to bolster the yuan. Financial institutions will be required to hold 6% of their foreign currency deposits in reserves starting September 15, down from the current 8%, according to a PBOC statement. However, the Securities Finance Times, a state-backed news outlet, said that the PBOC is more concerned about the pace of the yuan’s depreciation than with a specific exchange rate—a view that T. Rowe Price analysts believe signals official tolerance for a weaker yuan. The Federal Reserve’s hawkish policy has boosted the dollar this year and weighed on most emerging markets currencies. China’s surprise decision to lower key interest rates in August to boost a slowing economy has also contributed to the yuan’s slide.

Other Key Markets

Hungary

Hungarian assets were pressured again this week by two major external factors. The first was news late last week that Russia was stopping its natural gas flows to Germany via the Nord Stream 1 pipeline indefinitely. A reduction of Russian energy exports to Western Europe is particularly problematic for Hungary, as the country is heavily dependent on Russia for its energy needs. The second was the European Central Bank’s decision to raise interest rates by 75 basis points (0.75 percentage point) on Thursday. While Hungary is a member of the European Union, it is not part of the eurozone; thus it maintains its own currency and monetary policy.

During the week, the Hungarian government reported that year-over-year inflation in August was 15.6%. This was lower than expected but higher than the 13.7% year-over-year reading for July. T. Rowe Price credit analyst Ivan Morozov notes that natural gas and electricity costs remained almost unchanged despite a recent partial lifting of price caps, meaning other factors are contributing to inflation. Nevertheless, Morozov currently believes that inflation is likely to stay around current levels until early 2023 if gas and electricity prices are unchanged but could climb to a year-over-year rate of around 20% if the full lifting of the price caps translates into broadly higher prices.

Chile

Chilean stocks, as measured by the S&P IPSA Index, returned about -0.8%.

In a mandatory referendum held on Sunday, Chilean citizens decidedly voted against the new constitution that has been under development for more than one year and favored by President Gabriel Boric’s administration. Approximately 62% of the electorate favored keeping the existing constitution. Following the referendum, Boric shook up his cabinet, replacing six out of 24 ministers. However, Finance Minister and former central bank head Mario Marcel will remain in place.

On Tuesday, Chile’s central bank held its scheduled monetary policy meeting and increased its key interest rate by 100 basis points (one percentage point), from 9.75% to 10.75%. The magnitude of the rate increase was a surprise, as recent rate hikes had been only 75 basis points, reflecting policymakers’ belief that the central bank was in the latter stages of the tightening cycle. The 100-basis-point rate hike decision was not unanimous: Three board members favored the move, but one voted for 125 basis points, while another preferred 75 basis points.

On Wednesday, the central bank released its quarterly monetary policy report with new macroeconomic forecasts. Policymakers revised their 2022 growth estimate slightly upward, but they anticipate a deeper recession in 2023, which T. Rowe Price emerging markets sovereign analyst Aaron Gifford does not surprising, as interest rates were already well into restrictive territory before Tuesday’s larger-than-expected rate increase. Central bank officials also boosted their inflation forecasts. They now expect headline inflation and core inflation to be 12.0% and 10.5%, respectively (up from 9.9% and 9.7%, respectively), in 2022. In 2023, they now expect headline inflation and core inflation to be 3.3% and 4.7%, respectively (up from 2.7% and 3.8%, respectively).