Good news from the leading central banks pushed stock markets higher last week, with some even hitting new all-time highs. The primary driver of positive sentiment came from the US Federal Reserve Bank's March Federal Open Market Committee meeting and the press conference immediately afterwards: Fed fund rates are set to remain unchanged at 5.25% – 5.50%. More importantly, the FOMC is still anticipating three rate cuts in 2024, and a gradual decrease to around 3.1% by 2026.
Investors and market watchers responded favourably to Jerome Powell saying that he was not overly concerned by the recent uptick in inflation data in January and February. This, he suggests, can simply be attributed to “seasonal noise”. He also dismissed concerns over signs of potential cracks in the labour market, such as February’s unexpected increase in unemployment.
There is some concern, however, over the recent increase in the price of Brent crude oil – up around 12% year-to-date. Ukraine's recent drone attacks on Russia's energy infrastructure risk driving up global prices further. Despite sanctions on Russia – which remains one of the world's most important energy exporters – Washington has urged Kyiv to consider the possible implications of strikes on Russian energy supplies: they might result in retaliatory attacks on Western energy infrastructure.
In early March, Saudi Arabia and its partners agreed to extend current crude oil production cuts into the middle of the year. Production currently stands at two million barrels per day less than normal, and the International Energy Agency assumes that this will continue until the end of the year. This is partly why the IEA is now forecasting that global oil markets will face a supply deficit throughout 2024, instead of a surplus as previously expected. This could coincide with the traditional US summer driving season, which starts at the end of May and lasts until early September. This is important, since summer begins in the northern hemisphere and demand for gasoline is typically at its seasonal peak.
So if there were to be a demand-over-supply issue for oil, it could potentially push inflation back up, possibly even leading to a second wave of inflationary pressures. This would thwart central bankers in their overall aim of getting inflation back down to its 2% target level. The central banks generally agree that the “last mile” of the path towards lower inflation is generally the most arduous: there are likely to be bumps along the way.
Other leading central banks, including the Bank of Japan, the Swiss National Bank and the Bank of England also held important policy meetings this month.
Japan is up against a very different kind of problem: it has been desperately trying to boost inflation and get prices rising by around 2% a year. After years of low inflation and even deflation, the Bank of Japan has just unexpectedly raised interest rates for the first time since 2007. It has finally ended its era of negative interest rates, raising its base rate from - 0.1% to zero, reaffirming its loose monetary policy. After 17 years of negative rates, this is a major development.
While the Japanese central bank is worried that it might have moved too far too soon, it will continue to buy Japanese government bonds in a similar quantity. However, it will reduce the level of corporate bonds it purchases and stop buying exchange-traded funds and real estate investment trust shares. Intriguingly, both China and Japan avoided the high inflation levels seen elsewhere – despite being large energy importers. This can be attributed to the fact that they did not suddenly increase their money supply in response to the pandemic.
The Japanese stock market has recently been on a tear: the Nikkei 225 Index – in local currency – has rallied by 23% year-to-date and just under 50%, on a rolling twelve-month time horizon. Unfortunately, unless hedged, investors would have lost some of this gain to the unfavourable pound-to-yen exchange rate. However, with the Index having achieved a level last seen in December 1989 (and predicted to rise still further), Japan's increased popularity as an investable region has resulted in significant inflows.
In the UK, the Bank of England has kept its key interest rate unchanged at 5.25% for the fifth consecutive time. Members of the Monetary Policy Committee appear to be adopting a more dovish approach, however. Indeed, Andrew Bailey has indicated that interest rate cuts could actually be implemented before inflation hits the 2% target rate. This will come as a relief to homeowners with large mortgages. The UK’s inflation rate may have fallen to its lowest level in almost two and a half years. But given the recent spike in crude oil prices and ongoing conflicts in Eastern Europe and the Middle East, this is no time for complacency.
In Europe, dovish signals from central banks regarding future rate cuts have definitely boosted “risk on” sentiment among investors. The US has evidently outshone Europe from an economic perspective. But curiously enough, Europe's weakness might actually be its strength: there now seems very little standing in the way of the ECB cutting interest rates. Indeed, the Swiss National Bank surprised the market last week with an unexpected rate cut.
Furthermore, the European equity markets look more attractively priced from a valuation viewpoint than the US. They could therefore attract more interest from asset allocators. This could help to push European bourses much higher throughout the rest of 2024.
Elsewhere in Asia, the Chinese market has retreated as concerns over the property sector slump offset any optimism about better-than-expected economic data. The CIO of Goldman Sachs Wealth Management has even cautioned against investing in China given the steep declines that its stock market has suffered in recent times. With the fundamentals and momentum strengthening in the US, Europe, Japan and even India, investors are more inclined to increase their exposure to these regions in pursuit of healthier returns than to China.
Overall, the markets have continued to be buoyed by the prospect of interest rate cuts, the slower-than-expected reduction in inflation, better economic fundamentals and rising corporate profitability. In our view, the recent broadening out of the market beyond the mega-cap technology sector is a welcome sign of a healthy market dynamic. Excluding any unforeseen events, we appear to be on course for further rises in selective markets over the coming months. Needless to say, although this current bull market has further to go, we are likely to experience some corrective periods. As ever, they should be viewed as buying opportunities for quality assets – be they equities or bonds.
