Rate cut hopes dented

Global equities edged higher last week but performance differed significantly between regions. US equities gained 1.7% in sterling terms on the back of a strong performance from the tech sector. The S&P 500, the main US equity index, even hit a new all-time high, breaking above its previous peak in January 2022.

However, the celebrations were muted with the move being described as a limp to the summit. The caution stems from the fear that the rally rests both on hopes for substantial rate cuts, which look overblown, and the so-called Magnificent Seven (the seven largest US tech stocks) whose valuations now seem to be pricing in quite a lot of magnificent news.

Other regions were down on the week. UK equities lost 2.0% while China was down as much as 5.2%. China at the moment is rather the polar opposite of the US with the market reading the worst into every release.

There were in fact no big surprises in last week’s clutch of Chinese economic data. GDP grew 1.0% in the fourth quarter to be up 5.2% on a year earlier. Over 2023 as a whole, growth was also 5.2%, above the government’s 5% target which had been widely expected to be missed only a few months ago.

Instead, the pessimism stems from the continuing downturn in the property sector and no sign that the authorities are prepared to step up the scale of their policy stimulus, which so far has been piece-meal and limited. While this gradualist approach may well continue, the market does now seem to be assuming the worst. The price-earnings ratio for the equity market is back down to 8.5x, close to the lows seen at peak pessimism in 2022.

Elsewhere, UK gilts and US Treasuries both posted declines last week of around 1%. Yields rose 0.15-0.20% as the market scaled back somewhat its hopes for rate cuts. In the case of the US, this followed comments from Fed officials arguing against the need for rapid cuts and some strong economic numbers.

Specifically, a sizeable gain in retail sales in December, a bounce in consumer confidence in January and a fall in initial jobless claims to an 18-month low suggest there is still considerable life left in the US consumer and the labour market remains robust.

In the case of the UK, the latest inflation numbers were to blame. The headline rate unexpectedly edged up to 4.0% in December from 3.9%. As for the more important core rate, this had been expected to drop to 4.9% but instead was unchanged at 5.1%.

Despite this unexpected blip higher, inflation is still falling significantly faster than the Bank of England had been expecting and remains set to fall below 2% in April on the back of the fall in energy prices. Wage pressures also continue to ease with underlying average earnings growth slowing to 6.6% in November from 7.3%.

The December retail sales numbers caused a few wobbles to the soft-landing thesis as sales were down a surprisingly large 3.2%. But changes to shopping patterns in the run-up to Christmas mean the numbers are not the most reliable. And with real wages growing once again, there is little reason to think this decline heralds a downturn in consumer spending.

All said and done, expectations for rate cuts have been scaled back somewhat, not only in the US and UK but also in the Eurozone following comments from ECB President Christine Lagarde. The market now expects rates in all three regions to start being cut around May, rather than March, and to be down 1.25% or so by year-end in the US and Eurozone and 1% in the UK.

These expectations still look on the optimistic side but less so than before. The outlook for rates may become a little clearer following the ECB and BOJ meetings later this week and the Fed and BOE meetings next week…or then again maybe not.

Rupert Thompson – Chief Economist