Global equity markets have begun the year in a positive mood. Commentators are still hoping for a soft landing in the US, and there has been a significant mood change regarding policy rate reductions across the world's major advanced economies (with the exception of Japan).
An early setback on Wall Street has already been cancelled out, as investors are still expecting upbeat economic data. The drawback with that is that were the economy to overheat, then there would be less need for the central bank to cut interest rates any time soon.
The recent jobless claims report might force the Fed to delay any actions, leaving investors to think again. In fact, a fund rate cut from the Fed as early as March does indeed look unlikely – particularly given the recent uptick in inflation.
Meanwhile, the slightly higher bond yields have not (yet) resulted in a profound stock market sell-off. Indeed, Wall Street has actually been doing the exact opposite, and is currently seeing a “melt-up”. What this means is that the asset allocators who thought bonds were due for a period of outperformance against stocks will need to rethink their strategy and possibly wait a little longer.
The most recent headwind to impact the global supply chain is the spate of attacks perpetrated by the Houthi movement in the Red Sea, targeting major shipping lanes that are crucial for distributing goods to countries throughout the Western world.
Shipping companies having to divert around the southern tip of Africa to avoid being attacked adds significant costs (and time) to transport operations – costs which could eventually lead to higher inflation. News of further US-UK led strikes on the Houthis has added further tensions in the region.
There is every chance that the current hostilities could spread to other territories in the Middle East. Indeed, Iran and Pakistan have recently been engaged in a series of tit-for-tat missile and drone attacks. These retaliatory strikes are stoking fears of widening conflict and worsening geopolitical tensions across the region.
Last week, members of the World Economic Forum headed to Davos for their annual meeting – an opportunity for leaders and changemakers from all over the world to engage in discussion on political and economic matters, as well as the urgent issue of climate change.
The WEF differs from the World Health Organisation or the United Nations Climate Change Conferences, insofar as their meetings do not carry treaty or contractual obligations. The forum is only as influential as the power of its arguments and those in attendance. “Davos is where billionaires tell millionaires about what the middle class feels”, joked JPMorgan CEO Jamie Dimon at the forum one year. Indeed, accusations of it being out of touch are rife, and the WEF is concerned about loss of trust among its global audience and what this might mean for future Davos meetings.
Last week's headline data was the S&P 500 hitting a record high and breaching its January 2022 record. It has subsequently moved even higher. The US 10-year Treasury bond yield, meanwhile, rose to 4.2%. In commodities, gold fell by 1%, while geopolitical woes pushed Brent Crude Oil marginally higher.
The latest weekly US jobless numbers suggest that the Fed will sidestep any commitment to cutting interest rates in March. This will disappoint the bulls and the wider market.
Elsewhere in the world, China reported that its economy expanded by 5.2% last year. But this number was hotly disputed by numerous economists and market watchers, with some even claiming that the economy contracted over the year. In fact, other economic news from Beijing paints a bleak picture, seemingly confirming this.
Of even greater concern was the news that China's population has fallen for the second year in a row. Last year’s fall of 2 million is the fastest decline it has seen since 1961, highlighting the demographic challenges that lie ahead for the country.
UK inflation ticked up to 4% in December, with services inflation (closely monitored as a better measure of domestic prices) accelerating to 6.4%. Core inflation, excluding food and energy, held steady at 5.1% year-on-year.
The economic distortions of the past two years have evidently resulted in something of a tectonic shift in the global investment landscape. Initially, we had considerable fiscal stimulus and near-zero interest rates during the pandemic. This was followed by higher inflation and a ratcheting up of interest rates.
We have now entered a period of disinflation, with the expectation that interest rates will fall over the coming months. Unfortunately, the role of the central bank has become a little more challenging, with war not just in Europe, but in the Middle East as well. These conflicts have created a great deal of uncertainty globally.
While we are fairly confident that the economic investment backdrop is slowly improving, there is no shortage of geopolitical issues that could easily create problems for the markets and central bankers. They remain committed to bringing inflation back down to that 2% target rate and normalising interest rates. But the world will need to be a more stable place from both an economic and a geopolitical perspective in order for them to be able to do that.
