Global equities dropped a little last week for the second week running, falling 0.9% in local currency terms. However, a stronger dollar led to the pound dipping below $1.25 and markets were broadly unchanged in sterling terms. Asia, Emerging Markets and the UK all saw gains of 1% or so in sterling terms whereas the US was down slightly.
Meanwhile, bonds were down a little, as yields continued their recent upward climb led by the US. As for commodities, they rebounded further and gold led the way with a 4% rise and a break above $2400/oz. Gold has been buoyed recently both by the rise in geopolitical tensions and large central bank purchases.
All of these moves are prior to the Iranian missile attack on Israel on Saturday. But the market reaction to the weekend’s events is so far minimal with European markets even up a smidgeon at the time of writing. The Brent oil price is actually down slightly this morning and a bit lower than a week ago. At just under $90/bbl, it remains well below its 2022 high of $120.
The main economic news last week was the March US consumer price data which came in higher than expected for the fourth month running. The headline inflation rate rose to 3.5% from 3.2% while the more important core rate was unchanged at 3.8%.
Whereas the inflation numbers late last year were pointing towards a swift return to the Fed’s 2% target, recent data suggest inflation has stalled at 3-4%. Services and housing costs are the two areas where inflation is proving most stubborn.
Hopes for US rate cuts, which have already been reduced substantially this year, were duly scaled back even further. It is now looking increasingly likely that the Fed will not start easing before September and rates will be reduced by no more than 0.5% this year.
In the Eurozone by contrast, the market is still anticipating rates to be lowered 0.75-1.0% by year-end. At last week’s ECB meeting, President Lagarde continued to suggest rates should start to be cut in June although it remains data dependent.
Here in the UK, rates look set to be reduced over the summer with two 0.25% cuts looking likely by year-end. Wednesday’s inflation numbers are forecast to show both the headline and core rates falling back further to 3.1% and 4.2% respectively. Indeed, a temporary retreat in the headline rate below 2% is still on the cards for the next few months.
On the activity front, the UK economy appears to have returned to modest positive growth after dipping into a mild recession last year. GDP rose 0.1% in February and is up 0.2% over the last three months.
While markets will almost certainly continue to obsess about the speed of forthcoming rate cuts, two other factors will be centre stage over coming weeks. The first is the US earnings season which got off to a lukewarm start on Friday with the big banks. While JPMorgan and Citigroup beat expectations, the forward guidance disappointed and the stocks ended the day down.
Expectations are for S&P 500 earnings overall to be up in the first quarter a modest 3% on a year earlier, down from a 10% gain reported the previous quarter. And but for the Magnificent Seven, earnings would actually be down 3%.
The Middle East will be the other obvious focus of attention. Here, the risk of the conflict intensifying further has clearly risen but the carefully calibrated scale of the Iranian attack, along with Israel’s success in repelling it, means the market is still viewing this as just a tail risk.
This remains our base case too. And the lesson from most past geopolitical crises in the past is that from an investment point of view, the best approach is to remain firmly focused on the macro outlook, hard as it may be. If there were a major escalation, this would undoubtedly take its toll on equities, at least temporarily. But our government bond holdings and our small allocations to commodities/commodity-related equities should fare relatively well, limiting the damage.
Given the continuing uncertainties on both the macro and geopolitical fronts, the argument for having a well-diversified portfolio seem stronger than ever.
Rupert Thompson – Chief Economist