Bevan Blair, Chief Investment Officer, One Four Nine shares his latest market analysis
Inflation and central banks’ response to inflation via monetary policy are still the single largest influences on short-term returns in markets. It has been the key overriding theme since late 2021 and it shows no sign of abating as a determinant of short-term noise in markets.
As the first quarter of 2024 evolved, data indicated that, whilst falling, inflation was not decreasing at the rate of which was initially anticipated, and in the US, it even started to increase slightly again. Inflations ‘stickiness’ presents as one very large metaphorical spanner in the works for central bankers, as they had hoped that with their tight monetary policy, inflation would be firmly back at or near target by now.
Because of the stickiness of inflation, the market has had to reassess its outlook quite starkly. Now the market expects the first rate cut in the US to come in either August or September, estimating between 1 and 2 rate cuts this year with policy rate at year-end between 4.75% and 5.00%. This has been a significant shift of rate expectations in just three months.
The story is almost exactly the same in the UK and EU. In the UK now, the first cut is expected in August as opposed to May with between 2 or 3 rate cuts rather than 6 or 7 and the Bank of England (BOE) base rate will end between 4.50% and 4.75%, rather than 3.50% to 3.75%. It now looks likely that the European Central Bank (ECB) will be the first of the major central banks to move rates down as inflation there is now just 2.4%, with little economic growth to speak of to reignite it. In other words -they have room to cut.
Strong job market
One of the key reasons why we have not thus far entered a more prolonged economic downturn in the face of higher interest rates has been that labour markets have remained very strong. US job creation, as measured by non-farm payrolls, has exceeded expectations and been consistently positive. The US is adding jobs, even as monetary policy tightens.
In the UK, the unemployment rate has changed little in the two years since the hiking cycle began. Wages have on the whole not kept pace with inflation over the last three years but there has been some wage growth. While there is a cost of living crisis the fact that people on the whole remain employed has meant that even if their real take-home pay is lower, their nominal pay is higher and they remain employed.
Market performance
Equity and bond markets moved in opposite directions last quarter. Bond markets globally fell as yields expanded on revisions to interest rate expectations, while equity markets posted strong positive returns as momentum showed no sign of abating.
In the UK, the Gilt yields rose across all maturities, more so at the longer-dated end of the curve. The two-year Gilt yield rose from 3.98% to 4.17%, an increase of 19 basis points while the ten-year Gilt yield rose from 3.53% to 3.93%, an increase of 40 basis points.
It was a similar story in the US as yields rose across all maturities. The US ten-year treasury yield rose 33 basis points to 4.20% at the end of the quarter. US treasuries lost 0.94% over the quarter, less than the UK reflecting the lower duration of the treasury market in the US.
Equities meanwhile continued their strong performance from Q4 2023 into Q1 2024 with the MSCI world gaining 9.88% over the quarter in sterling terms. There was some style differentiation with growth stocks gaining 11.24% and value stocks gaining 8.47%. Quality stocks performed even better gaining 12.59%.
There was significant regional variation, tempered by currency movements. Japanese and US equities were by far the strongest performing regions during the quarter delivering double-digit returns in both local currency and sterling terms. Returns from the UK, Asian and Emerging markets were significantly behind those of Europe, Japan and the US, as they were last year.
Rates on the horizon
We are now at the end of the current rate rising cycle, although importantly the necessary conditions have not materialised yet, in relation to stronger than expected economic data minimising the room to cut.
When rate cuts do happen we do not expect rates to head back towards the “emergency” levels of 2008 to 2021. Central Banks will want to keep some rate powder dry for the next existential crisis they may face.
Markets, both bond and equity, are very focused on the number and timing of rate cuts and we feel they will be in a period of range trading until they get clarity from central banks about when these cuts may happen. Until then markets will be noisy and directionless. Maybe once we get the first rate cut markets can end their obsession with rates and inflation and focus on growth as a driver of market returns, with fixed income retreating to a more predictable dull market, as it should be!
