18th March 2024
Markets last week
Equity markets experienced a relatively tranquil week in anticipation of major central bank rate decisions this week, including those of the US Federal Reserve, the Bank of England, and the Bank of Japan
Global equities ended the week nearly unchanged, but the weakening of the pound supported international equity returns when converted back to GBP
Yields on most Western government bonds rose as investors adjusted their exposures ahead of the imminent central bank decisions
Dialogue within the ECB Governing Council hinted at a shift towards a more dovish stance, with several members indicating a potential rate cut in the upcoming months
Spreads on European periphery yields have tightened, indicating improved fiscal sustainability in Europe
Japanese equities experienced profit-taking ahead of the Bank of Japan's decision tomorrow, resulting in a 2.1% decline in local currency terms for the week. Nonetheless, year-to-date gains remain substantial at 12.9%
US inflation data was a notable highlight, revealing a slightly higher-than-anticipated inflation rate for February. Deeper analysis suggests a continuing trend of moderating inflation.
Analysis
It was a calm week for equity markets ahead of a busy week this week with several key central bank rate decisions, including the US Federal Reserve (Fed), the Bank of England (BoE) and the Bank of Japan (BoJ). Global equities broadly finished where they started, with sterling weakness supporting international equity returns when converting back to GBP – for instance, global equities finished marginally down in US dollar terms but up 0.51% in GBP. Similarly, the US equity market closed down 0.1% in local currency terms but was up 0.8% in sterling. The pound weakened 0.9% against the US dollar (helping GBP denominated investors).
It was a busier week for rates markets, with yields on most Western government bonds rising as investors trimmed their exposures ahead of the busy central bank agenda this week. The yield on the US 10-year Treasury note rose 0.23%, closing at 4.31% and re-testing the peaks of the year so far. The bond market has given back some of the gains made in the final two months of last year as yields have risen year-to-date, but the 10-year yield remains well below the 5% peak in October of 2023. UK gilt yields rose in sympathy with US Treasury yields, with the 10-year rising 0.13% to close at 4.1%. The 10-year German bund yield rose 0.18% to close at 2.44%.
The dialogue within the European Central Bank (ECB) Governing Council appears to have shifted towards a more dovish stance, as evidenced by remarks made by several members in their communications last week. There is still a notion that the ECB is unlikely to cut rates ahead of the Fed but inflation in the Eurozone has abated faster and European economies have been more sensitive to interest rates. Governing Council member Francois Villeroy de Galhau, of the Bank of France, said in a newspaper interview “Since our Governing Council meeting last week, there’s a very broad agreement to cut rates in the spring”, indicating a potential cut in the June meeting. The spreads on European periphery yields have tightened aggressively in March, accelerating a trend that had persisted before. The spread between the five-year Italian yield and the five-year German bund yield has tightened from over 1.5% in October last year to below 0.8% currently. As spreads narrow, fiscal sustainability improves, creating a self-reinforcing cycle. Spreads are currently approaching their 2021 lows.
After a good run year-to-date, there was some profit taking in Japanese equities ahead of the BoJ decision on Tuesday. In local currency terms, Japanese equities were down 2.1% last week but remain up 12.9% year-to-date. The weakness in the yen has eroded some of the gains for unhedged GBP investors; adjusting gains to sterling takes the year-to-date return to 6.9%. There is a huge amount of anticipation surrounding the BoJ decision, with hopes that the bank will hike rates either this week or in the April meeting, potentially marking their first rate hike since 2007. It’s likely that the pull-back in the equity market was simply a ‘buy-the-rumour-sell-the-news’ type scenario.
US Inflation data was the most notable piece on the economic calendar last week and was an important data point before the Fed meeting on Wednesday. The data revealed a slightly higher-than-anticipated inflation rate for February. The headline figure rose to 3.2% year-on-year from 3.1%. Despite being slightly hotter than expected, the market reaction was muted, with the US equity market posting a new all-time high on the day. While core inflation (excluding volatile food and energy) was marginally lower on a year-on-year basis, it exceeded expectations.
Despite the mild surprise, there are notable positives to glean from the inflation report that suggest a trend towards moderating inflation. First, core inflation dropped to the lowest reading since the spring of 2021. Secondly, inflation is now almost entirely down to services prices, particularly housing, which exhibits a lag, and there are indications that housing costs are easing too. If you exclude shelter from the Consumer Price Index (CPI) number headline and core inflation drops to 1.8% and 2.2% year-on-year, respectively – within the comfort range for the Fed. Overall, while the inflation narrative in the US remains finely balanced, the data continues to suggest disinflation over reflation.
The Week ahead
Tuesday: Bank of Japan rate decision
Our thoughts: The BoJ could steal the show this week. If they do hike rates, it would mark their first hike since 2007, and would bring an end to their negative interest rate policy. Recent data has pointed to healthy wage growth and inflation. Now, the focus has shifted back to the central bank. Markets imply a 56% probability of a hike in tomorrow’s meeting. The BoJ has been softening yield curve control in recent months and a rate hike appears likely. This could drive up Japanese bond yields, which would likely bolster the yen.
Wednesday: FOMC rate decision
Our thoughts: Rate cut expectations have softened this year, but the Fed is still expected to cut rates heading into summer, with the first cut priced in for July. Although the inflation data has surprised to the upside this year and the trend is more finely balanced, the evidence continues to point to disinflation. Chairman Powell is expected to reaffirm that while the Federal Open Market Committee is not in a rush to cut (and they shouldn’t be), their confidence in implementing cuts this year is increasing.
Thursday: Bank of England rate decision
Our thoughts: We anticipate no change in interest rates in the UK, although the balance of votes on the Monetary Policy Committee could shift more in favour of a cut. UK CPI inflation data released tomorrow will be an important indicator. The recent slowdown in wage growth has been a good sign that inflation is falling, pointing to rate cuts later this year.
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