Financial Bulletin – February 2024

Overview

January witnessed financial markets pare back their expectations for rate cuts this year despite continued progress on bringing inflation back to target.

The US economy once again surprised economists with how resilient it remains and is estimated to have grown faster than expected in the fourth quarter of the year.  

On the other side of the Atlantic both the UK and Eurozone economies remain fragile, although the latest surveys pointed to a modest improvement.

During the month manufacturers began to report rising costs due to some cargo ships having to avoid the Red Sea. The situation has the potential to make inflation harder to bring back to target.  

In China the authorities unveiled yet more stimulus measures in an attempt to boost confidence, whilst in Japan the BoJ signalled that its era of negative interest rates may be coming to an end.  

Over the last 6 months the FTSE 100 returned 0.85%, the S&P 500 returned 6.18%, whilst the Euro Stoxx 50 returned 4.45%.

The Japanese Nikkei 225 returned 8.72% over the same period.

The broad emerging markets index returned -6.00% in US$ terms.

US government bond yields were fairly flat on the month whereas UK government bond yields crept higher.   

US Economic News

After the eventful final Fed meeting of last year, during which the Central Bank strongly hinted that rates will be cut throughout 2024, bond markets started to price in a cut as soon as March.

During January several Fed members attempted to temper this expectation and the markets’ expectation for the first rate cut was slowly pushed out.

However, the bond market continues to believe that there will be more rate cuts next year than the Fed is projecting.  

Ultimately which view prevails will come down to the strength of the US economy and during January the latest growth figures beat expectations once again.

Growth in the final quarter of 2023 was estimated to be 3.3% (annualised) – well ahead of the expected 2%.

Moreover, more recent surveys suggest that this momentum has been maintained at the start of 2024.

Meanwhile the Fed’s preferred measure of inflation fell to 2.9% in the year to December, indicating further progress on bringing inflation down to target.

UK Economic News

There was a slight uptick in UK inflation in the year to December, from 3.9% to 4%, although most economists expect the downward trend to resume from next month.

Whilst the economy remains subdued, and could potentially have entered recession at the back end of last year, the latest surveys were slightly brighter.

The hugely important services sector is thought to have accelerated at the fastest rate since last May.

The manufacturing sector, meanwhile, continued to contract.

However, businesses across both sectors recorded an increase in cost pressures.

In the services sector this was mainly attributable to wages, although the latest official figures suggested that wage growth continued to moderate. Wage growth has now slowed for 5 months in a row.  

In contrast manufacturers blamed higher costs on growing problems in Red Sea shipping routes.

Attacks by Iran-backed rebels have forced commercial ships to find alternative, more costly, routes.

If the cost of transporting goods continues to rise then this may be a factor in policymakers’ interest rate decisions.

Eurozone Economic News

After falling to just 2.4% in the year to November Eurozone inflation rose to 2.9%.

Although this was a significant jump it was in line with expectations.

Inflation is expected to fall back over the coming months as the 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 have contracted further in the final three months of the year.

The German economy, Europe’s largest, is almost certainly in recession.

The latest surveys from the Eurozone suggest the region contracted during January but at the slowest rate for 6 months.

As in the case of the UK, manufacturers reported supple chain problems resulting from the problems in the Red Sea.

The European Central Bank left its key interest rate unchanged after the January meeting, as expected, but noted that underlying inflationary pressure continues to ease.  

Wider Economic News

The Chinese authorities unveiled yet more stimulus measures in an attempt to boost consumer and stock market confidence.

However, further evidence of the poor fundamentals of the Chinese economy came in the shape of Evergrande.

Evergrande, which at its height was the largest property developer in China, has been ordered to liquidate after running up too much debt.

This highlights the debt and overcapacity in the Chinese property sector.

Elsewhere, in Japan, the economy is estimated to have accelerated in January.

The Bank of Japan is widely expected to end its negative interest rate stance in the coming months.  

Financial Markets and Corporate News

The momentum which pushed stock markets forward at the end of 2023,  continued through January.

A combination of hopes for lower interest rates and better-than-expected growth in the US gave equities a tailwind.

Over the last 6 months the FTSE 100 returned 0.85%, the S&P 500 returned 6.18%, whilst the Euro Stoxx 50 returned 4.45%.

The Japanese Nikkei 225 returned 8.72% over the same period.

Summary of Key News:

  • US economic growth beat expectations once again.
  • US inflationary pressure continues to abate.
  • However, the US Fed seems in no rush to cut interest rates.
  • The UK and Eurozone economies showed some signs of improvement but remain lacklustre.
  • The Chinese authorities unveiled more stimulus measures but fundamental problems remain.
  • The Bank of Japan could be on the cusp of ending the era of negative interest rates.
  • Tensions in the Red Sea are causing supply chain problems and increasing cost pressures.

Financial Markets:

  • Most stock markets made solid gains during January.
  • Over 6 months the FTSE 100 returned 0.85%, the S&P 500 returned 6.18%, and the Euro Stoxx 50 returned 4.45% (total return).
  • The Japanese Nikkei 225 returned 8.72% (total return).
  • The broad emerging markets index returned approximately -6.00% (in US$ terms).
  • The   IA UK Gilts    sector    returned 3.93% over 6 months, whilst the IA Sterling Corporate Bond sector returned 6.67%, and the IA Sterling High Yield sector returned 6.56%.

Outlook

Barring further economic shocks the US Fed, Bank of England and European Central Bank will be making several rate cuts during 2024.

However, the timing of the first cut and the total amount of ‘easing’,  remain  keenly debated topics and a key driver for financial markets.

The problem is that the US Federal Reserve is projecting that only three cuts will be required next year, whereas the market is expecting more like double that amount.

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.

Based on the latest economic developments, the Fed seems to be closer to the truth than the market as the strength of the economy suggests significant cuts are not required.

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

The major regions of the world are therefore on quite divergent paths, with the US looking robust, UK and Eurozone facing recession, Japan normalising interest rates, and China dealing with fundamental problems.