Several niggling concerns have combined to reduce investor optimism, despite the initial boost of a lower than expected inflation read in the US. Our head of markets reports.
US inflation data is increasingly vindicating the Federal Reserve view that the previous spike was transitory. Signs of normalisation, as evidenced by easing of semiconductor issues which had caused used car prices to rise, is a promising development. It is now expected that over the short term the labour shortages in sectors such as leisure and hotels will begin to reverse, as people feel more comfortable in venturing out to seek employment.
However, inflation is one part of an economic jigsaw which suggests slowing growth. Concerns over profit margins given the pressures on raw materials have begun to surface ahead of the upcoming third-quarter reporting season around the beginning of October. In addition, possible corporate tax hikes could put further pressure on profits, especially compared to the highly successful recent round of second-quarter results.
The main indices have therefore pared recent gains, although still in healthy shape in the year to date, with the Dow Jones having added 13%, the S&P500 18.3% and the Nasdaq 16.7%.
Elsewhere, Asian markets were also subdued after further weakening Chinese economic data, such as retail sales, depressed sentiment. Localised lockdowns are crimping growth, while higher raw material prices and slowing industrial output are also providing headwinds which the region is currently battling.
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UK markets have inevitably suffered given the global narrative, as the cyclical focus of many FTSE100 constituents leaves those companies at the mercy of faltering economic growth. The premier index is at a distance from the highs hit earlier in 2021, with the FTSE100 up by 8.8% in the year to date.
More positively, the general progress of the UK economy has so far exceeded expectations, with the fallout from the pandemic being partially offset by recovering demand. The more domestically focused FTSE250 remains ahead by 15.5% so far this year, and has also been underpinned by some brisk M&A activity, driven by the perception of lower valuations here.
Meanwhile, inflation rose to a higher-than-expected 3.2% in the year to August, although the distorting effects of the Eat Out to Help Out scheme and VAT discounts in the corresponding period last year will fall away. Even so, the figure will remain elevated for the moment with the squeeze in supply chains, higher raw material prices and wage inflation all adding pressure.
The Bank of England will likely reiterate its stance in line with the Fed that the inflation issue is temporary, and while the next few readings will continue to influence the timing of any monetary policy tightening, a rise in interest rates is not seen as being on the cards until perhaps 2023.
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