Market Update 18th December 2023
A Christmas Carol
“Mar(kets)ley was dead to begin with. There is no doubt whatever about that” – the opening line of Charles Dickens’ A Christmas Carol which I’ve shamelessly adapted for my purposes here – but this was the broad view of markets this time last year, or the spirit of Christmas past! The consensus view back then was that major economies would slip into recession as inflation and sharp interest rate hikes would stifle demand. Interest rates in the US and the UK in December last year had just been hiked by 0.5% to 4.5% and 3.5% respectively. US 10-year bond yields were at 3.5% and 10-year Gilts were at 3.25%. Inflation was running at 10.5% in the UK and 6.5% in the US.
But the global economy and markets turned out to be a lot more resilient than predicted. Some of the main reasons we didn’t see widespread recessions included the excess savings households had built up during the pandemic, the delayed impact of interest rate hikes and, in the US in particular, the fiscal support the Government provided to boost demand.
Encouragingly, the spirit of Christmas present is a different picture. It now appears inflation is heading in the right direction. Core inflation numbers in the US and Eurozone have been coming down and are running at about, or just below 4%. The most recent inflation data for the UK showed a sharp fall in the headline rate to 4.6%. Importantly, UK core inflation whilst higher, is also heading in the right direction gradually too, with the latest print coming in at 5.7%.
Central Banks from around the world have also just provided their latest deliberations on interest rates. The Fed, the Bank of England and the ECB each continued to keep rates on hold. Notably however, the Fed released its latest ‘Summary of Economic Projections’, including the ‘dot plot’ of where Committee members felt rates will be over the coming years. This pointed towards an average of about 0.75% of rate cuts by the end of 2024. This gave immediate encouragement to markets looking for any signs of confirmation that a ‘pivot’ from rate hikes to rate cuts is on the cards and bond yields fell sharply accordingly. Whilst Chairman Powell tried to maintain a degree of balance in his press conference afterwards, the market took his comments as not pushing back too hard on the direction of travel.
By contrast, both the Bank of England and the ECB adopted a much more hawkish tone. In line with the previous meeting, six MPC members backed keeping rates on hold, whilst three members even supported a further hike. The accompanying statement continued to suggest policy would need to be sufficiently restrictive for sufficiently long to bring inflation back to target. The ECB noted price pressures remain elevated, and importantly, ECB President Lagarde, said rate cuts were not discussed. This may have all been a concerted effort to fight against any over-easing of financial conditions as the drop in US bond yields drags down the UK and European curves.
We have to get the crystal ball out to think about the spirit of Christmas yet to come. Currently, our best guess of where we’ll be by this time next year is that we’ll have experienced a shallow recession. This will likely mean that we’ll see bank rates come down a bit which should act as a support for both bonds and equities. That said, if we get a harder landing, central banks are likely to need to respond with sharper rate cuts.
However, given the uncertainty and the range of outcomes, we still see diversification as key. Although we think equities should do ok and perform well as the slowdown phase passes. Bonds and alternatives provide other sources of returns should growth stall or inflation pick up respectively. As we move into 2024, a well-diversified portfolio will help negotiate these different scenarios.
All turns out well in the end for Ebenezer Scrooge in A Christmas Carol. We think the foundations are in place for the same to be true of markets into 2024.
Our next Innovation article will be out on January 8th, so in the meantime it just leaves me to wish you and your families a wonderful Christmas and a prosperous new year.
Simon Reynolds – Head of Research
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