Investment Comment
3rd February 2023
Nearly there
A trifecta of central banks raised interest rates again this week and yet markets soared as it becomes clear that, after a rapid climb, the top of this hiking cycle is in sight.
First up was the US Federal Reserve who, as widely anticipated, raised interest rates by 25 basis points, signalling a slowing in their tightening efforts. The statement from Jerome Powell was measured, recognising that inflation "has eased somewhat but remains elevated" but balancing the smaller move with some suitably hawkish rhetoric warning “that ongoing increases…will be appropriate in order to attain…policy that is sufficiently restrictive”.
Yet when it came to the subsequent press conference the hawkish wheels came off and the dove took flight, at least in the mind of the market. Powell appeared to shift his tone from the immediate need to tackle inflation to a more balanced medium-term outlook, commenting that “the disinflation process has started” and did not push back against the idea of interest rate cuts later this year.
The market’s takeaway from Powell’s comments is that the Fed could cut rates later this year if inflation fades rapidly. With many indicators pointing to a downturn in economic activity and inflation levels falling, the Fed’s comments were viewed as a tacit endorsement of market pricing. In response, bond yields fell sharply, and stocks rallied, most notably those high growth names (perceived to be most interest rate sensitive) that were hammered last year as rates rose but have bounced back as inflation fears have subsided. Whether that bounce is of the “dead-cat” variety, i.e. temporary, or a more persistent trend will become clear in time.
Back in Europe the other two “big” banks, the Bank of England, and the European Central Bank (ECB) also announced rate rises, raising interest rates by 50 basis points respectively. However, the rhetoric was very different.
The European Central Bank raised interest rates by 50 basis points, as expected, and guided for a similar move next month. The ECB is expected to maintain a more hawkish narrative, as they have been slower to raise so far (ECB target rate is 2.5% versus 4% in the UK), and the economy is performing much better than expected.
In London, while Bank of England Governor, Andrew Bailey, stated that “…it’s too soon to declare victory (over inflation) just yet…”, forecasts showed that the Bank expects inflation to fall rapidly to its 2% target next year and keep on falling as the economy falls into recession. Markets now expect just one more rate rise before we reach the top of the interest rate cycle, followed by cuts later in the year to support the economy.
Of recessions and earnings
After a trifecta of bank rate decisions, came a trifecta of results as yesterday three of the biggest and most important companies in the world reported earnings. Apple, Alphabet and Amazon, technology bellwethers with a combined market value of nearly $5 trillion, posted results showing that an economic slowdown is throttling demand for electronics, cloud computing and digital advertising – mainstays of the global tech economy. Recent weeks have seen a raft of job cuts in the technology sector, as companies adjust themselves to a slower growth environment.
Thus far the fourth-quarter season has been relatively disappointing, with earnings number continuing to be cut. Nevertheless, despite earnings downgrades, markets have rallied on investor optimism with global equities (MSCI World) up nearly 10% year-to-date. While economic data has improved, particularly in Europe as gas prices have fallen, and with renewed optimism as China reopens, recessionary risks remain very real and despite downgrades we don’t believe that earnings expectations discount a recessionary impact.
Gareth Thomas Head of Investment Management
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FP20230203002 EXP 03/03/2023