What does the chart show?
 
This chart shows the S&P 500 earnings yield compared to the yield on 10-year US Treasuries since 2010 as a way of measuring the Equity Risk Premium (ERP) over time. The S&P 500 earnings yield gauges the earnings generated by index constituents relative to the index’s current price. When earnings yields are low compared to historical values, this suggests equity markets are overvalued as earnings are not keeping up with price gains, the reciprocal of the Price/Earnings (PE) ratio. A popular way for investors to measure ERP is to compare this to the yield on 10-year US Treasuries - the additional return investors are compensated with for taking on higher risk relative to risk-free assets. For investors, this can show the relative attractiveness of stocks compared to bonds and determine allocation weights between asset classes in portfolios. As shown in the chart, the ERP for the S&P 500 (illustrated by the gap between the two yields), is currently at its lowest point in 12 years, since 2007.

 Why is this important?

 The S&P 500 has experienced a significant surge in 2023, and valuations have outpaced earnings growth. Consequently, there has been a decline in the broad market’s earnings yield, indicating a potential overvaluation of these equities. With valuations so stretched against a backdrop of recession risks and a potential downturn in company earnings, the uncertain economic climate does not seem to be factored into markets. On the other hand, Treasury yields have spiked following numerous rate hikes by the Federal Reserve, and with inflation figures cooling, markets now predict we are nearing peak rates. However, some investors argue that ERPs are no longer comparable to historical levels, asserting that current equity valuations are justified given the recent advancements in technology. Optimists foresee these developments will lead to increased productivity, and consequently the higher earnings potential of companies. Furthermore, following the recent debate surrounding the quality of US credit, questions have been raised regarding whether US Treasuries can still be used as a benchmark for risk-free assets. Albeit that most investors still view US government bonds as the cornerstone of multi-asset portfolios, which provide a safe haven in times of economic uncertainty. Regardless, investors need to determine whether the ERP is worthwhile when investing in US equities - where valuations are arguably stretched - given the real yields that US treasuries are offering today.

What does the chart show?

This chart illustrates the trends in US 30-year treasury yields over the last three years compared with the total outstanding US public marketable debt, highlighting how the rise in yields aligns with an increase in public borrowing. Over the last week, the yields on these bonds climbed to the highest levels seen this year, reaching 4.32% following concerns regarding the trajectory of US debt leading to a credit ratings downgrade enforced by Fitch, and an announcement by the Treasury of an increase in borrowing in Q3. This is only the second ratings downgrade ever, after the S&P global ratings agency’s downgrade in 2011, and has put the spotlight back on the USA’s worsening fiscal outlook. 

Bonds are rated by assessing the financial strength of issuers such as governments and corporates, ranking their ability to meet debt payments. These ratings are often used by investors when allocating risk in a portfolio and determine how much interest a borrower pays when raising funds in capital markets. The change from AAA to AA+ comes following the introduction of tax cuts and new spending initiatives, alongside a number of economic shocks which have contributed to a US debt burden that is projected to reach 115% of Gross Domestic Product by 2025. Furthermore, several political standoffs concerning the US debt ceiling have prompted a reassessment of policymakers' commitments to address the country’s sizeable and increasing debt. The downgrade now means that Fitch no longer regards US credit, often seen as the world’s risk-free asset benchmark, to be of the highest quality.

Why is this important?

US treasuries play a pivotal role in global markets and have long been a cornerstone of investor’s portfolios due to their widely acknowledged safe-haven status. As a benchmark for risk free assets, they impact interest rates and investment decisions worldwide. Consequently, the finances of the US and fiscal trajectory directly influence investor’s perception of risk and the government’s ability to service its debt, and therefore can have large impacts on the demand and pricing of US treasuries. Since Fitch’s decision last week, many have dismissed the verdict as irrelevant and unnecessary. Critics including the Treasury secretary Janet Yellen have pointed to the resilience of the US economy, with growth so far this year surprising to the upside and the resolution of the US debt ceiling debate, arguing that the US’s ability to make a repayment on its debt remains unquestionable. 

Prominent investors such as Jamie Dimon and Warren Buffet, have similarly downplayed the significance of the news, stating that Fitch’s statement provides markets with no information that is not already priced into markets and that US treasuries remain the preferred asset haven of choice. Whilst US fixed income markets experienced sell-offs last week, these were also attributed to a ramp up of bonds sales to fund the widening budget deficit, rather than solely being a response to the ratings change. While it is important for investors to monitor the government’s handling of US finances, what is currently likely to have more of an impact on bond rates is the shifting outlook for economic growth, inflation, and interest rates. The US always expects to be number one, so whilst the ratings downgrade is not likely to have a lasting impact on markets, it may have rattled the nation’s pride and also provides fuel for political debates in the upcoming elections.

What does the chart show?
 
This chart shows the total aggregated private investment in Artificial Intelligence (AI) from 2013 to 2022 by country. As AI becomes more and more integrated into the economy, the race for dominance in this transformative technology has intensified, with private investment acting as a key indicator of influence. The US, China, and the UK are the clear leaders, with private investment over the decade totalling $248.9 billion, $94.8 billion and $18.2 billion respectively. As a leading player in this movement, the US has demonstrated its commitment to keep up with the rapid pace of innovation, having passed more legislation relating to AI than any other country. Notably, the US has mandated comprehensive training for all AI-involved workers to be aware of its capabilities and associated risks. 

 Why is this important?

 The widespread integration of AI has come with a whole new range of possibilities, alongside causes for concern. Questions continue to be asked on how these new advancements will impact the economy with regards to productivity, wages, unemployment, and sustainability. Forecasts predict a potential 7% year-on-year increase in Gross Domestic Product over 10 years, driven by boosts to productivity. Furthermore, companies have reported improved outcomes in costs, enhanced collaboration across business units, and more efficient organisational processes. These optimistic forecasts have already been reflected in markets with the NASDAQ-100 Technology Sector Index up more than 50% this year. Therefore, the country which takes the reins in terms of market power will wield an immense level of influence and have the potential for huge economic gains. However, as the adage goes, with great power comes great responsibility! Given the potential for massive disruption with regards to cyber security and mass unemployment if not implemented appropriately, governments will need to carefully craft regulatory frameworks to control a phenomenon dominated by a small set of private sector players fuelled by profit motives and fierce competition, rather than economic sustainability and society’s best interests. Security risks aside, there is also the danger of a new wave of de-globalisation as the gap widens between developed and emerging countries. Large language models, like Google’s recent release of PaLm (which required 360 times more data and was 160 times more expensive to produce than the first ChatGPT-2 model), present higher technical and financial barriers to entry in the AI space. Emerging nations may struggle to keep pace with the AI wave and may start falling behind as developed nations reduce their overall dependence on cheap foreign supply chains. If the current trend in investment continues, the US may be faced with the task of deciding how AI will shape our future. 

What does the chart show?
 
This chart shows the spreads on US corporate debt. Spreads, which are the difference between the yields on a fixed income security and the yields on the almost risk-free US treasuries, show the risk associated with that security. A wider spread indicates a riskier security, given that investors require higher yields, taking on greater risk of a firm defaulting, due to things like weaker balance sheets or when economic conditions are more difficult. US corporate debt is then divided into the two separate groups of investment grade (IG), which is considered lower risk and then the riskier high yield (HY) credit with their groups determined by ratings given by agencies such as S&P and Moody’s. The market’s interpretation of their relative riskiness can then be seen using credit spreads. US HY credit has an average spread of around 500 basis points (bps) with IG credit’s average spread closer to 150 bps. The spreads of both groups currently sit below their long-term averages with HY at 418 bps and IG at 124 bps.

 Why is this important?

 The recent perfect storm of higher interest rates, cooling economic activity, and the US banking crisis have resulted in extremely difficult credit conditions for US firms. The Federal Reserve’s Senior Loan Officer survey showed a significant proportion of banks were tightening up their standards for business loans and the firms that are able to take out loans will find their interest expenses greatly increased after years of easy money. The impact of these tough conditions is already evident with bond default rates and bankruptcies on the rise. If an inverted yield curve is once again a successful predictor of a recession in the US, default and bankruptcy rates are likely to worsen. Despite the issues facing US corporate borrowers, bond markets don’t seem to have got the message. Having risen throughout 2022 as recession expectations grew, the spreads on both IG and HY credit have fallen below their long-term averages, effectively suggesting that the outlook for these bonds is better than it normally would be. HY corporate borrowers with their weaker balance sheets, lower quality businesses, and more cyclical revenues are especially vulnerable to an economic downturn, and yet spreads have given no indication of any nervousness. Either corporate bond markets are unconvinced by the noise surrounding the likelihood of an impending recession, or they simply believe that US firms will be able to weather any difficult periods, possibly due to the expectations of fiscal or monetary support. There are also hopes that a future easing of credit conditions will relieve US firms of any real pressure from higher interest rates. However, with core inflation expected to keep rates higher for longer, US corporate borrowers and their debt may begin to face more problems than they expected.  

What does the chart show?

This chart shows the target interest rates of several major central banks. Central bank interest rates are a monetary tool that, among other things, are used to help control inflation within an economy by stimulating or cooling economic activity. When central banks raise interest rates they discourage borrowing and spending among businesses and consumers. This may damage short-term economic growth but can be necessary when inflation is too high. Alternatively, the lowering of interest rates helps to stimulate growth by encouraging borrowing and spending. The graph shows how, across most major economies, central banks have been forced to raise interest rates from the historic lows seen during the pandemic, to tackle high levels of inflation. Over the past year and a half, rates have risen from virtually 0% to as high as 5.25%. For many monetary authorities, these are the highest that rates have been since before the 2008 financial crisis. One outlier is China where rates, which were at much higher levels during the pandemic, have instead been cut. The rate on the People’s Bank of China (PBOC) medium-term lending facility (MLF) currently sits at 2.65%.

Why is this important?

While activity in economies such as the US and the Eurozone has continued to surprise to the upside, China’s momentum since reopening has already begun to falter. Year-on-year growth in key areas, such as retail sales and industrial output, is still positive but has disappointed especially given last year’s low base during lockdowns. Chinese exports declined in May and are unlikely to recover as global activity struggles under the load of higher rates. The focus now turns to the Chinese authorities who are under pressure to hit the 5% growth target set at the beginning of the year. The cutting of the main policy rate shows some intent by the PBOC, but a cut of just 10 basis points is unlikely to make enough of a difference. It is possible that China is wary of the kind of measures seen recently in western economies, given the inflationary consequences of those policies. China itself has suffered from a stimulus driven rise and subsequent fall of its property market which has yet to fully recover. However, with inflation nearing deflationary levels, there is certainly some room for the PBOC to cut rates. Some fiscal stimulus is also expected to target problem areas, such as the property sector and youth unemployment. Some tax breaks have already been implemented, but measures so far have been underwhelming. It is also possible that more than just monetary and fiscal stimulus is required to help change China’s fortunes. For now, however, the focus remains on whether Chinese authorities are as concerned about the economy’s faltering momentum as some onlookers are.   

What does the chart show?
 
This chart shows the performance of a variety of major asset classes in the first half of 2023. Global Developed Market Equities, as shown by the MSCI World index, continued their strong performance from the end of last year to finish +15% despite facing difficulties during the US banking crisis in early March. The turmoil during the crisis helped drive the price of gold which has since slightly receded to finish +5.2%. Emerging Market Equities (as measured by the MSCI Emerging Market Equity Index) lagged Developed Market Equities, but still finished the first half of the year almost +5%. Even with all the uncertainty in markets, US Fixed Income Securities have remained stable so far this year, with US Treasuries and US Investment Grade credit returning +1.6% and +3.2% respectively. Having outperformed significantly in 2022, Commodities have struggled to date in 2023, finishing the first half of the year -7.1%.

 Why is this important?

 2023 has been a fascinating year so far, as markets recover from a difficult 2022. At first glance there are reasons for optimism, with positive performance in equities in both Developed and Emerging Markets. However, there are concerns over the breadth of this year’s Equity rally, especially in the US where the majority of returns are attributable to just a few large stocks, mainly in the high-growth technology industry. Outside of these firms, returns have been muted, suggesting that an element of caution is still prevalent for the months ahead for the wider market. The performance of Fixed Income Securities also seems to indicate significant levels of uncertainty. Investors have struggled to reach a decision on future economic outlook, as inflation and economic strength have continued to defy expectations, despite the ongoing rate hikes. This has led to fluctuations in bond markets throughout 2023. Even with this uncertainty in bond markets, both Treasuries and Investment Grade Credit have delivered positive returns to investors so far this year. Fears of an impending recession are more evident in the performance of Commodities. Expectations of a cooldown in economic activity have driven commodity prices steadily downwards throughout the year. While this steady decline has brought the price of Commodities down from their 2022 peaks, which has helped to ease inflation, prices are still higher than their pre-pandemic levels, leading to suggestions that this may simply be a normalisation from the extreme levels seen last year, rather than due to increasing fears of a recession. Wide deviations in asset class performance this year have contributed further to the uncertainty in markets, but while short-term risks remain, the volatility in markets mean that longer-term opportunities are continuing to emerge. 

What does the chart show?
 
This chart shows the currency composition of the foreign exchange reserves of global central banks. The holding of reserves by central banks is an important tool for ensuring the stability of a country’s currency, which provides predictability to businesses, investors, or financial institutions that operate internationally. Countries with less stable financial institutions hold reserves in more reliable and globally accepted currencies, such as the US Dollar (USD) or the Euro, to back up the value of their own currencies. In 2000 almost 90% of global reserves were held in either Euros or USD. The decline of this figure to 78% at the end of 2022 has been driven almost entirely by a falling proportion of reserves being held in USD, that has fallen from 71% to 58%. Reserves held in Chinese Yuan have risen to 2.69%.

Why is this important?

There are few better ways of showing the USA’s economic and financial might than the pre-eminence of the USD in both global trade and as the preferred foreign exchange reserve currency. However, with the proportion of foreign reserves being held in USD having gradually declined since the year 2000, questions are being asked whether the dominance of the Dollar will last. Rising geopolitical tensions have led to some countries such as Brazil and Russia raising security concerns over US weaponisation of the Dollar. Last year the US was able to freeze $130 billion of Russian reserves as retaliation for their invasion of Ukraine. One issue in reducing reliance on the Dollar is finding a suitable alternative. The price of gold surged higher late last year due to large central bank purchases with the precious metal being identified as a possible Dollar replacement for backing up a currency. There are also suggestions that the Chinese Yuan could act as a reserve currency for countries that are unable or unwilling to deal in Dollars. In recent years, China has emerged as a rival to the US’s financial and political dominance which has led to rising tensions between the two superpowers. However, with just 2.7% of global reserves being held in Yuan, the Dollar remains a clear favourite. To increase the global influence of the Yuan, China has also gone after another, arguably more important pillar of Dollar dominance: global trade. In 2018 China opened an oil exchange where contracts for the world’s most traded commodity were settled in Yuan rather than Dollars. However, China’s more stringent capital controls and less developed financial system have meant that traders have remained wary and so the proportion of global trades being settled on the Shanghai exchange has risen to just 5%. The Dollar’s position as the global reserve currency of choice appears to still be strong and the lack of a realistic alternative means that it may well stay that way for some time.

What does the chart show?
 
This chart shows the year-on-year core inflation for the UK, US, and Eurozone. The core inflation rate, which is different to the more commonly used headline inflation rate, shows the change in the price of the same basket of goods but excludes things that have more transitory or volatile price changes, such as food and energy. Both food and energy are commodities that can be traded on exchanges which is what makes fluctuations in their prices more volatile so do not reflect longer term price changes. With a basket made up of less volatile goods and services, core inflation tends to change at a slower pace than the headline inflation rate. Having risen steadily in the US, Eurozone, and UK throughout 2022, rising above 6% in the US and UK, and reaching 5.7% in the Eurozone, there are now indications that core inflation is starting to fall in the US and Eurozone. However, in the UK core inflation has continued to rise reaching 6.8%, its highest level since March 1992.

 Why is this important?

 Last year’s combination of supply chain difficulties and Russia’s invasion of Ukraine drove up commodity prices and with them, headline levels of inflation. Since then, the steady declines in prices have begun to move headline figures back towards their long-term target level of 2%. However, even with headline inflation showing signs of having peaked, central banks continue to indicate that the fight against inflation is far from over as stickier core inflation remains stubbornly high. This problem is particularly relevant in the UK where, despite a falling headline rate, core levels have continued to rise. The issue has largely been attributed to the UK’s labour market which has remained tight, unlike in the US and Eurozone where it has shown signs of cooling. The UK’s high inflation has led to an 18-month run of falling real wages but with the labour market remaining consistently tight, the effects of workers having more bargaining power when it comes to wage increases are emerging. Average wages in the UK rose by 7.5% year-on-year in April, giving a clear indication that the UK has entered a wage-price spiral with an ongoing feedback loop of higher prices leading to higher wages, leading to higher prices. The consequences of sticky core inflation are clear. While other central banks are considering pauses or even cuts to rates by the end of the year, markets are now expecting five more hikes from the Bank of England in 2023, putting further pressure on UK households and businesses as borrowing costs rise. Growth in the UK has surprised to the upside so far this year with the economy defying the expectation of it being the worst-performing G7 economy. However, the possibility of further hikes in the near future means that those predictions may still come true.

What does the chart show?
This chart shows the price of a barrel of Brent Crude Oil over the past five years, which is one of the major benchmarks used to set global oil prices. Given crude oil’s ability to be refined into widely used products such as petrol, diesel and the chemicals needed to make plastics, it is one of the most traded commodities in the world with the price often being used as an indicator for global economic activity. Prices fell below USD20 in 2020 when global output collapsed during the COVID-19 pandemic but recovered strongly as post-pandemic activity began to return. The aftermath of the pandemic, combined with the Russia-Ukraine war, saw the price of oil spike in early 2022 reaching almost USD128 per barrel and not falling below USD100 until August 2022. Since then, the price of oil has continued to decline throughout 2023 falling to approximately USD76 today.

Why is this important?

 Oil continues to be one of the most important commodities in the world and over the past year has been a useful metric for gaining insights into the two main themes that have been prevalent in markets recently: inflation and the possibility of a recession. Rising commodity prices were one of the drivers of the extraordinary rates of inflation seen last year and oil was no exception. This year the falling price of oil is expected to bring some relief to economies struggling with inflation. However, more interestingly are the reasons behind oil’s steady decline in 2023. Predictions of a recession in western economies has meant that demand for oil was expected to fall, but this drop in demand was expected to be offset by increased demand from a Chinese economy coming out of COVID-19 lockdown restrictions. At the beginning of the year the expectation was that this boost could push the price of oil back up to USD100. China’s re-emergence has so far underperformed expectations, and although things like air travel in China remain below their pre-pandemic levels, the continued decline in the oil price suggests that China’s disappointing performance isn’t expected to change any time soon. The steady decline of the oil price is a concern for some countries that rely heavily on revenues from the export of oil. In April, the Organisation of the Petroleum Exporting Countries (OPEC), which represents 40% of the world’s crude oil production, announced a further production cut of 3.66m barrels per day, equivalent to about 3.7% of global demand. This cut resulted in a brief spike in price before the decline continued, forcing OPEC to extend the duration of production cuts by a year to the end of 2024. Whether this has the desired impact of propping up the price of oil is yet to be seen, but so far, the reaction has been muted. If the oil price continues to trend downwards, it will be clear that  markets are sharply focused on an expected decline in global economic activity.

What does the chart show?
 
This chart shows the current US average 30-year (Y) fixed mortgage rate versus the number of mortgage refinancings. The 30Y fixed mortgage rate is the average rate offered by mortgage providers on home loans to borrowers. This rate then stays the same throughout the entirety of the 30-year term unless the loan is refinanced, or the home is sold. The refinancing index gives an indication of the number of mortgage refinancings in the US housing market. The index is rebased to 100 at 1990 levels, with an April 2023 value of 443 suggesting that the number of refinancings was more than 4x times higher than when the index was first measured. This value is still significantly lower than the index value of 4,781 seen during the earliest stages of COVID-19. Having fallen steadily to as low as 2.88% is early 2021, the average offered rate has risen dramatically to 7.13%.

 Why is this important?

 The state of the US housing market is closely linked to the health of the US economy as a whole. Rising house prices generates a wealth effect for consumers whose houses will often be their most valuable asset. The housing market is also one of the ways interest rate hikes from the Fed feed through to consumers, and eventually tackle inflation. Higher rates increase the cost of borrowing as seen by the increase in the average mortgage rate. The expectation is that higher monthly mortgage payments lead to lower demand for other goods from consumers, and so economic activity cools. However, the US housing market is unique globally in that the dominant home mortgage product is a 30-year fixed rate mortgage, meaning that until it is refinanced the borrower pays the same rate for the entire term. In other countries the dominant mortgage product is either a shorter-term mortgage that needs to be refinanced more frequently, or a variable rate mortgage that matches a base rate such as the local central bank rate. When interest rates fell during the pandemic, the average offered 30Y rate fell too, reaching an all-time low of 2.88%. Consumers jumped at the opportunity to refinance and lock in a historically low rate for their mortgages with the volume of refinancings at its highest since 2013. The effect is that US consumers have remained largely unaffected by the Fed’s aggressive rate hikes. The volume of refinancings has plummeted and the proportion of newly built versus existing home sales currently sits at twice its historical average, both suggesting that US homeowners are extremely unwilling to give up their low-rate mortgages. Consumption has recently been the sole driver in helping the US economy avoid a downturn. The surprisingly healthy position of US homeowners could help to explain why.