As a proud Welshman (don’t mention the rugby please) I have to start my email on March 1 by saying Dydd Gŵyl Dewi Hapus - Happy St David’s Day
The rugby last weekend was arguably more exciting than markets this week, with most days very quiet for news flow, and the major highlight being the US Core PCE numbers, which is the Federal Reserve’s preferred measure of inflation. The lack of nasty surprises in the data was enough to push US equities to fresh all-time highs yesterday. We’ve also seen Japanese, Indian and European indices at record highs over the week.
The US PCE data showed inflation slowing to 2.4% year on year in January, down from 2.6% in December, in line with expectations. The perceived risk was the data not slowing, pushing back even further expectations of rate cuts. Therefore, markets breathed a sigh of relief that the data contained no surprises. Elsewhere in the economic numbers, India reported its GDP data for the fourth quarter of 2023, showing year on year growth of 8.4%, well ahead of the 6.6% expected. Thus, Indian equities were trading at all-time highs today. The other economic data of note was the flash PMI numbers, published last Friday, but too late to be included in last week’s update. The overall tone of the data was positive, with the US, UK and eurozone figures all moving higher, though the eurozone data was still in “contraction”. The UK data was well into “expansion” territory, pointing to positive economic growth in the first quarter should this trend continue. Manufacturing continues to be weak in the UK but this is being outweighed by the strength in the services sector.
As we start a new month, and after a strong start to the year in some markets, it’s a good time to question if the current market momentum can continue. US and Japanese equities have carried on leading markets higher, as we saw in 2023, and investor sentiment gauges are approaching euphoric levels. The US market has seen some more breadth to the recent rally, even if most of the headlines continue to be around the “Magnificent 7” stocks and Nvidia in particular. Earnings season, outside of the biggest companies, has been somewhat mixed, but with economic numbers in the US still solid, the backdrop is still supportive. Even in Europe and the UK, there are hints of a turn in the data, suggesting the recession will have been short lived.
It is impressive that equity markets have performed so well thus far this year, particularly in the US given the interest rate backdrop, with expectations for rate cuts shifting so much since the start of the year. On January 12, futures markets were pricing 168 basis points of rate cuts from the Fed this year. The Fed’s own “dot plot” pointed to 75 basis points of cuts when they last updated their predictions for rates in December. Today, futures markets are pricing around 80 basis points of cuts this year. Thus, markets have followed the Fed’s guidance, with several Fed speakers emphasising the need for patience and the difficulties of the “last mile” to bring inflation back to targets along the way. The backdrop to this messaging from the Fed has been a US economy that is proving resilient and may well continue to do so if expectations of various tax cuts (it’s an election year remember) prove correct.
Inflation has also proved sticky in some places such as services, and housing sector inflation, which lags other inflationary data, has taken time to roll over. However, the trajectory of inflation remains pointed in the direction of rate cuts, which seems more likely much later in the year, once the Fed has digested more inflationary data and had more insight on the path of the economy. There has even been some chatter that the next move in interest rates will be higher. While we have already seen bond yields, which move inversely to prices, move significantly higher over the year, as economic concerns dissipate, and expectations shift further out regarding when central banks will cut rates, that is definitely not priced into markets.
The outlook elsewhere is mixed. China remains under a dark property shaped cloud for now, and while it is clear the authorities are looking to support markets, for investors to take a more positive view on the country, it seems that more significant stimulus is needed rather than the consistent trickle of minor policy changes we have seen so far. Closer to home, the UK and eurozone appear to be showing signs of “green shoots”, dare I say it. However, a return to strong growth appears unlikely, not least because while interest rates will likely fall, they will not fall by far, and on the fiscal side, the piggy bank is empty. Japan remains somewhere that does look interesting. Though growth may well remain volatile, the normalisation of policy from the Bank of Japan, and continued shift in how companies allocate capital towards more shareholder friendly outcomes should be a tailwind.
Markets in some places do have some strong momentum for now, not least the US, which seems to be following the usual trajectory in an election year. If this continues to be the case, we may see some consolidation soon as the primaries process firms up and the market starts to ponder over the policy consequences of the Presidential candidates. We also need to keep a close eye on the economic data – history, and my economics textbooks, shows monetary policy works with a lag. We are yet to see the full impact of rate hikes – helped by the fact that many households and corporates are still yet to see the impact of the past two years of policy normalisation. The lag between rate hikes and the full impact on the economy may well have dissipated for this reason; financial conditions remain benign and credit remains available. Hence inflation may take a little longer to come down, but the worst-case economic outcomes from such an aggressive round of interest rate hikes look to have been avoided.
Have a good weekend,
Kind regards,
Anthony.
