Financial Bulletin – January 2024

Overview

The year ended in eventful fashion as the US Federal Reserve gave the strongest hint yet that, in their view, interest rates have peaked.

In the press conference following December’s meeting Chairman Jay Powell openly admitted that the timing of interest rate cuts was discussed at the meeting.  

As a result both equity and bond markets rallied strongly into the end of the year.

In contrast both the Bank of England and European Central Banks were much more cautious in their tone.

In fact one of the biggest surprises of the month came when three members of the Bank of England’s committee voted for another rate rise.

Both the Eurozone and UK economies are estimated to have contracted in the third quarter of the year, whilst growth in the US was revised down.

These developments only served to heighten expectations for rate cuts.  

Over the last 6 months the FTSE 100 returned 4.61%, the S&P 500 returned 7.65%, whilst the Euro Stoxx 50 returned 3.27%.

The Japanese Nikkei 225 returned -0.86% over the same period.

The broad emerging markets index returned 3.07% in US$ terms.

Both US and UK government bond yields fell substantially during the month as the prospect of interest rate cuts next year became more likely.   

US Economic News

The US Federal Reserve kept interest rates on hold during December, as widely expected.

However, much more significantly, the Central Bank is now projecting that three rate cuts will be required next year as inflation will be lower than expected.  

Moreover, at the press conference following the decision Chairman Jay Powell made no real attempt to dampen expectations of rate cuts next year.

The latest economic developments during December suggest that the Fed is right to view monetary policy as already tight enough.

Not only was growth in the third quarter revised down from the previous estimate but more forward-looking indicators point to a fairly subdued economy.

The manufacturing sector continues to act as a drag on output and the sector deteriorated again in December.

The huge services sector improved marginally during the month but growth remains slower than earlier in the year.

The headline inflation rate fell to 3.1% in the year to November compared to 3.2% in the previous month.

UK Economic News

There was another substantial fall in UK inflation in the year to November, this time to 3.9%. In fact, UK inflation has now fallen from 6.7% to 3.9% in the space of two months.

At the same time growth in the third quarter was revised down; from 0.0% to -0.1%. This means that if the economy contracted in the final quarter of the year then it would officially be in recession.

It therefore came as a surprise to many investors that three members of the committee actually voted for a further rate rise. Nevertheless,  a majority voted for no change.

Arguably the rationale used by those voting for a rate rise is that core inflation, which excludes energy and food prices, is not falling as fast as headline inflation and remained above 5% in November.

The most recent indicators suggest that the UK economy may just avoid an official recession after growing in the final month of the year.

In a similar situation to that of the US economy it was the services sector which dragged the economy forward whilst the manufacturing sector continues to contract.

Eurozone Economic News

Inflation in the Eurozone fell to just 2.4% in November, which is the lowest rate since July 2021.

Perhaps more importantly the drop was significantly larger than many expected.

Inflationary pressure is falling as the region’s economy teeters on the edge of recession.

After contracting in the third quarter of the year it appears quite likely that the Eurozone economy will contract further in the final three months of the year.

The latest surveys suggest both the manufacturing and services sectors contracted in the final month of the year.

Despite inflation now only just above 2% and an economy close to recession, the ECB was far more conservative in tone compared to the US Fed.

The President of the Central Bank, Christine Lagarde, claimed there was no talk of interest rate cuts at all during the meeting.

Wider Economic News

Sentiment towards the Chinese economy remained firmly negative during the month.

That said the latest surveys pointed to some improvement as both the manufacturing and services sector are estimated to have accelerated.

President Xi made the unusual move of directly addressing poor economic performance during his New Year address. This speaks to the seriousness with which the authorities are taking the current economic predicament.

Elsewhere the Japanese economy contracted by more than expected in the third quarter of the year and the manufacturing sector contracted at a faster rate.

Financial Markets and Corporate News

Stock and bond markets rallied strongly into the end of the year as the prospect of meaningfully lower interest rates next year gave investors cheer.

However, markets are pricing in more like 6 rate cuts next year rather than the 3 projected by the Federal Reserve.

Over the last 6 months the FTSE 100 returned 4.61%, the S&P 500 returned 7.65%, whilst the Euro Stoxx 50 returned 3.27%.

The Japanese Nikkei 225 returned -0.86% over the same period.

The broad emerging markets index returned 3.07% in US$ terms.

The Investment Association (IA) UK Gilts sector returned 7.51% over 6 months, whilst the IA Sterling Corporate Bond sector returned 9.97% and the IA Sterling High Yield sector returned 6.91%.

Summary of Key News:

  • The US Federal Reserve projected three rate cuts next year.
  • Growth in the US, UK and Eurozone came in below expectation.
  • The UK economy contracted in the third quarter.
  • UK inflation fell significantly for the second month in a row.
  • Eurozone inflation is now down to 2.4%.
  • China’s economy marginally improved during December.

Financial Markets:

  • The prospect of interest rate cuts next year caused a rally in equity and bond markets.
  • Over 6 months the FTSE 100 returned 4.61%, the S&P 500 returned 7.65%, and the Euro Stoxx 50 returned 3.27% (total return).
  • The Japanese Nikkei 225 returned -0.86% (total return).
  • The broad emerging markets index returned approximately 3.07% (in US$ terms).
  • The   IA UK Gilts    sector    returned 7.51% over 6 months, whilst the IA Sterling Corporate Bond sector returned 9.97%, and the IA Sterling High Yield sector returned 6.91%.

Outlook

Barring further economic shocks it is likely that the US Fed, Bank of England and European Central Bank have made their last rate rise for this cycle.

Following the Federal Reserve’s latest meeting financial markets have become increasingly confident of consistent rate cuts next year.

The problem is that expectations have now moved so far that the bond market is pricing in around 6 rate cuts next year – far more than the 3 rate cuts currently envisaged by the Federal Reserve.

This opens up the possibility that markets will be disappointed by the extent and speed of any rate cuts.

Alternatively, if as many as 6 rate cuts are required, then it may be because the US economy is weaker than first thought.

At some point equity markets may begin to view falling interest rates less as good news and more as a sign of a weak economic outlook.

In the UK and Eurozone, meanwhile, the chances of a ‘soft-landing’ are extremely remote given that both economies are already stagnating.

This is before the majority of recent Central Bank rate rises have had their full economic effect.

More broadly, the length and depth of economic downturns will now determine where asset prices go from here.