It looks like the Santa Rally well and truly arrived this week, with big moves upwards in both equities and bonds. The key driver seems to be the belief that central banks have now come to the end of the rate hiking cycle and will “pivot” very shortly, beginning interest rates cuts in 2024. There has been a big shift in market narrative from the summer months when “higher-for-longer” was the clear message.
It was a busy week for central banks, however, before they met we did receive US inflation data on Tuesday, which came in at 3.1% (year-on-year), in line with expectations. This was a slight drop from the previous month’s figure of 3.2%. The data cemented the US Fed’s decision to hold interest rates. While this was expected, it was Fed Chair Powell’s statement that led to asset markets bouncing. It’s clear that the US Fed are now willing to cut rates in 2024, even if the economy is not in a recession, with the US Fed currently expecting to cut interest rates three times next year. The market went further than this, and after hearing the speech from Powell, quickly priced in six rate cuts in 2024. The expectation of lower rates, which will support both consumers and corporates sent the Russell 2000 (US small cap index) up over 3% on Wednesday, with a similar return on Thursday. The index is now at a 52-week high, having been at its 52-week low only 48 days ago! Nearly all equity markets joined the party, with the tech-heavy NASDAQ index reaching all-time highs, and the S&P 500 fast approaching its all-time high, which occurred on 2nd January 2022. Lower rates acted as support for bond markets; the US 10-year government bond yield dropped below 4% this week, having hit a 16 year high of 5% only weeks ago. In such a risk-on environment, coupled with lower interest rate expectations, we have seen the USD weaken against a basket of currencies, including Sterling, which is approaching 1.28.
Both the Bank of England (BoE) and European Central Bank (ECB) followed suit and held rates steady. However, there was a difference in commentary with both Andrew Bailey (BoE) and Christine Lagarde (ECB) stating they are yet to consider interest rate cuts. It appears the market isn’t convinced of this and are pricing in cuts starting next year. Weaker than expected UK GDP data on Monday highlighted that the lagged effects of higher rates are beginning to bite and supports the view that the BoE will be forced to cut rates to support the economy as we look into 2024. Much like the US, we saw bonds rally, with the UK 10-year government bond yield dropping as low as 3.7% this week. Equities advanced, with the more domestic focussed UK mid-cap index benefitting the most, rising over 3% on Thursday. In general, small and mid-cap equities are seen as more interest rate sensitive and therefore stand to benefit the most from lower rates going forward. While positioning here has been painful at times, it’s pleasing to see the recovery over the last six weeks.
It wasn’t just bonds and equities that performed well this week, we saw gold rebound after a lacklustre start to the week. The prospect of inflation with lower rates (falling real yields), coupled with a weaker dollar boosted the precious metal, with the price per ounce moving back above $2,000. Commodities such as copper also performed well on the back of a weaker dollar and the expectation of more supportive policy from developed market central banks.
Purchasing Managers’ Index (PMI) from Europe and the UK, released this morning, highlighted that most countries were seeing contraction in manufacturing and services sectors, once again pointing towards a slowing global economy. This will do little to dampen the views that interest rates will need to drop next year to help ease the strain on economies and support economic growth.
After months of oscillating markets, there has been a shift since the start of November, with the consensus now firmly pointing towards a peak in interest rates, with cuts just round the corner. In terms of inflation, the narrative is that the battle is largely won, the white flag has been waived, and we will approach the 2% target in 2024/2025. Indeed, Eurozone inflation is already at 2.4%, a whisker away from target. The positive correlation we have seen between bonds and equities has now worked in investors favour (as opposed to 2022), with both asset classes rising together. Within portfolios it’s been pleasing to see a broadening out of equity market participation with some of the small and mid-cap funds performing well. While it hasn’t always felt comfortable to be invested in 2023, portfolios are now at their highest levels for the calendar year.
Andy Triggs, Head of Investment & Nathan Amaning, Investment Analyst.
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