I’m guessing I’m not alone here, but the new year brought renewed vigour to my campaign to get a bit fitter and healthier. I’ve even joined a gym – not something I’ve done for a long time. I much prefer running outdoors but darker evenings, poor weather and dodgy knees make that trickier in the winter. Early results have been mixed. My low enthusiasm for a running machine or a stationary bike is unchanged and something doesn’t quite feel right on the cross-trainer. On the bright side, the rowing machines have potential. I’m also doing well in the sauna and steam room. So not all bad.
It has been a mixed start to the year in terms of markets too. The back end of last year had seen the Fed add extra weight to some better-looking inflation numbers by signalling that 3 rate cuts were now their average estimate over the course of 2024. This provided further fuel to markets forecasting rate cuts in terms of both how soon central banks start to cut, and the extent of those cuts over the course of the year. There were sharp declines in bond yields and a further bounce across equities as markets ended the year on a high.
As we’ve entered the new year, the festive excitement started to unwind and the mood came down with the Christmas decorations. As a result, there’s been something of a reassessment of some of those rate cut prospects. Markets had priced in over 150bps of rate cuts by the Fed by the end of 2024, but cuts as dramatic as these have rarely been seen outside of recessions. And the likelihood of rate cuts foreseen by the fund management community was higher than either in March 2020 at the onset of covid, or in 2008, at the onset of the Financial Crisis.
We may well still see the US fall into a recession, and the Fed take action accordingly, but recent data releases suggest a soft landing still looks the most likely outcome. Recent GDP and labour market releases have been stronger than anticipated, and with inflation falling, the Fed might feel in no particular hurry to cut rates – certainly not with the speed and magnitude that the market has been forecasting. The pricing of a Fed cut by March is back down to around evens at best. Bond yields have gradually ticked back up again and the US 10 year yield is sitting comfortably back above 4%
The end of year rally in equities was also notable in its breadth. It wasn’t just the Magnificent Seven powering things forward, smaller companies got a lift from the improved sentiment too. However, following a subdued first couple of weeks of the year for large cap tech, confidence has been restored in all things AI with some strong results announced by semiconductor stocks ASML and TSMC. Microsoft also reached a market capitalisation of $3 trillion, with its partnership with OpenAI at the heart of its continued move upwards, this has helped US equity indices regain some poise, despite the shift upwards in bond yields.
Geopolitical risks and the increased tensions in the Middle East remain a wildcard at the moment. We’ve seen Pakistan and Iran in tit for tat missile strikes. And further Houthi attacks on shipping vessels in the Red Sea. It’s likely there’s going to be some knock-on effects on supply chains and shipping costs. Research by JP Morgan delved into shipping costs in more detail, reporting that the Suez Canal represents c.30% of global containership volume, 12% of global tanker volume, and 6% of global bulk volume. With shipping companies opting for longer routes, spot freight rates have increased. These rates are likely going to feed into higher costs for both goods and imported energy. JP Morgan also reported global headline CPI inflation typically rises by c. 0.7% when global shipping costs double. Historically, rising shipping costs have had a more enduring impact on inflation relative to rising prices for other goods, highlighting that the rise in global shipping costs in 2021 contributed c. 2 percentage points to global inflation in 2022. Something to keep an eye on.
As the new year and my fitness campaign kick into gear, we maintain the view that we’ll see a steady slowdown as the lagged effect of previous rate hikes starts to have more of an impact. Central bank rates may come down in response, but I suspect not as quickly as currently priced in. Equity markets should do okay as long as the slowdown doesn’t deteriorate into something deeper and corporate earnings don’t come under more severe pressure.
Simon Reynolds – Head of Research
All charts and data sourced from FactSet
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