Global equities maintained their upbeat mood last week, building on their gains of the previous week with further gains of 1-2%. There was no real news driving markets higher, just continued relief that interest rates have probably now peaked and a soft landing in the US is looking more likely.
Markets also remain remarkably relaxed about the conflict in the Middle East. The Brent oil price has retreated further and is back down close to $80/bbl, well below the high of $95 touched in September.
Meanwhile, government bonds saw yields tick higher, reversing some of their drop the week before. Even so, 10-year yields remain some 0.2% below their October peak.
Central bankers did their best to impress on markets that rates need to stay higher for longer and no early cuts are in prospect. Jerome Powell, Christine Lagarde and Andrew Bailey all basically trotted out this same line. But while markets now accept there will be no reduction in rates over the winter, they are pricing in rates starting to be cut from the spring. In all three regions, the expectation is that rates will be 0.5-0.75% lower by the end of next year.
Although rates will most likely be cut as the market hopes, it is still far from a done deal. Considerable uncertainty remains over the macro outlook – most importantly whether, given the continuing strength of the economy, US inflation will fall sufficiently to allow rates to be reduced.
The other complicating factor is that market hopes of policy easing are behind the latest fall in bond yields and somewhat perversely are actually reducing the chances of these rate cuts materialising. The earlier rise in yields had tightened financial conditions and was doing some of the central bank’s job for them. But now bond yields have fallen back, this tightening has been unwound.
On the macro front, it was a quiet week with the main news being that the UK economy held up better than expected in the third quarter. GDP was unchanged, rather than down a little. This left the UK faring slightly better than the Eurozone, where activity contracted 0.1%, but underperforming the US significantly where GDP grew as much as 1.2%.
The UK economy looks set to continue to flatline over the coming year. The worst of the cost of living crisis may be behind us but a good part of the rise in rates has still to hit. Any tax give-aways in the Autumn Statement on 22 November are likely to be minimal and limited to some potential tinkering with stamp duty and inheritance tax and an extension of business investment allowances.
This coming week, inflation will be the main focus with October numbers released on Tuesday in the US and Wednesday in the UK. Core inflation is expected to remain unchanged in the US at 4.1% but the headline rate should ease to 3.3%, unwinding some of the rise in the last couple of months.
As for the UK numbers, they are likely to be greeted with delight by Rishi Sunak but somewhat less enthusiastically by the markets. Whereas headline inflation is forecast to fall sharply to 4.8% from 6.7%, fulfilling the PM’s pledge to halve inflation by year-end, the core rate should decline only marginally and remain worryingly high at 5.8%.
Rupert Thompson – Chief Economist