The Return of Monetary Tightening

September marked the shift from a phase of pause to a new cycle of monetary tightening. With the conflict in the Middle East keeping Brent at around 100 dollars and inflation above target, the Federal Reserve, the European Central Bank and the Bank of Japan all raised their policy rates in the same month. Long-term yields reached near two-decade highs in the United States and the United Kingdom, and the premium demanded on French debt widened to 2012 levels. For multi-asset portfolios, it was an adverse month: bonds and equities fell in tandem, gold offered no protection, and only the dollar and energy compensated and only in part.

In the United States, the economy entered September stronger than earlier data had suggested, with second-quarter GDP revised upwards to 2.2% annualised, 162,000 jobs created in August and the unemployment rate at 4.1%. Inflation, however, explained the Fed’s decision: consumer prices rose 3.4% year-on-year, with energy advancing 16.3%, while core inflation eased to 2.4%. On 16 September, the Fed raised rates, unanimously, to a range of 3.75% to 4.00%, and its chairman, Kevin Warsh, declined to give forward guidance. By the end of the month, the implied probability of a further hike in October had fallen from around 70% to 50% or less.

In the euro area, the ECB raised its three policy rates by 25 basis points, unanimously. Activity gave it room to do so, with the composite PMI at its highest level in 41 months. Fiscal policy once again differentiated between issuers: in France, a deficit of 5.4% of GDP, a record issuance programme for 2027 and two negative rating-agency decisions drove the 10-year spread over Germany from 85 to 128 basis points, the highest since 2012. Portugal stood out on the positive side: Fitch upgraded the Republic’s rating to A+, the budget surplus reached 0.5% of GDP in the first half of the year, and the PSI advanced 2.4%, against the European trend.

In the bond market, the US curve rose almost in parallel: the 2- and 10-year yields increased by 54 basis points, to 4.88% and 5.29%, and the 10-year ended the month at its highest level since 2007. Almost all of the rise in the 10-year yield came from the real component (49 basis points, against 5 from breakeven inflation), which points to a repricing of monetary policy and the term premium, rather than of inflation expectations. In credit, quality made the difference: the spread on dollar investment grade widened by just 4 basis points, while that on high yield increased by 49 in the United States and 41 in Europe.

In equity markets, the MSCI ACWI fell 1.3% in dollars, with the Nasdaq Composite rising 1.9% and the S&P 500 giving up 0.5%, while the STOXX 600 lost 2.5% and China’s CSI 300 fell 5.8%, despite the new stimulus package. Leadership was narrow: within the S&P 500, only technology and communication services rose, and defensive factors offered no protection. Earnings continue to underpin the market, with consensus pointing to growth of close to 30% in the third quarter, but valuations have lost their cushion: the S&P 500 is trading at around 19 times expected earnings, that is, an earnings yield of 5.3%, practically equal to the yield on 10-year US Treasuries.

On the currency front, the dollar once again acted as a protective asset: the DXY index rose 2.0% and the euro fell 2.5%, to 1.13 dollars, penalised by the rate differential and French risk. For a euro-based investor, unhedged currency exposure offset part of the losses on US assets; hedged exposure had no such buffer. In a shock originating in oil, only energy and the dollar served as an effective hedge: Brent rose 14.4%, to 103.53 dollars, in a month of renewed escalation with Iran and with no agreement on reopening the Strait of Hormuz, while gold fell 6.6%, in line with the rise in real yields and the dollar rather than with geopolitics.

The scenario of synchronised monetary tightening in the face of a persistent energy shock would be confirmed by still-elevated energy inflation, by central banks maintaining their restrictive tone at the meetings of 28 to 30 October, and by third-quarter earnings in line with estimates; it would be called into question by an agreement to reopen the Strait of Hormuz, by weaker US employment that removes room for manoeuvre from the Fed, or by a financing crisis in France that forces the ECB to choose between inflation and sovereign spreads.