Market Developments
After a strong end to 2023 for most asset classes, January saw more divergence across financial markets. Developed equity markets generally posted modest gains, helped by an encouraging start to the fourth-quarter (Q4) earnings season, but their emerging counterparts were weighed down by a stronger dollar and disappointing Chinese economic data. Government bonds gave back some of their recent gains – especially UK gilts – though credit spreads ground tighter. Commodity indices were little changed; oil prices were driven up by conflict in the Middle East, but natural gas prices sank as an outage at a US export terminal sparked fears of domestic oversupply.
Throughout November and December, safe havens and risk assets alike had rallied powerfully amid growing confidence that receding inflationary pressures would soon allow key central banks to start cutting interest rates. In January, however, this notion was undermined by some surprisingly strong US economic data, upticks in inflation in the US, UK and the eurozone, and what was widely seen as a ‘hawkish hold’ by the Federal Reserve.
Inflation & Rates
A surprise increase in headline inflation for December – from 3.9% to 4.0% – dampened expectations of interest-rate cuts by the Bank of England (BoE) and put pressure on gilts. The BoE’s Monetary Policy Committee met at the end of the month, and announced on 1 February that it would keep rates unchanged, pushing back against expectations of early interest-rate cuts.
Labour-market metrics in the UK had softened in recent quarters but now appear more mixed. While wages look to have peaked and seem to be easing in the private sector, the unemployment rate has ceased climbing.
The BoE has now signalled a peak in the tightening cycle, with the next move likely to be a cut. However, risks have resurfaced around the fiscal backdrop and recent improvements in economic data.
Europe
The European Central Bank (ECB) also kept rates steady, and although policymakers struck a slightly more dovish tone than in previous meetings, they reiterated that more progress on reducing inflation was needed before cuts would be considered. The eurozone economy narrowly avoided a recession in the fourth quarter of 2023, but the flash services and manufacturing PMIs remained in contractionary territory in January, despite a slight improvement in aggregate.
Recent eurozone macroeconomic indicators have been weak, due to slowing growth in Asia and restrictive monetary policy. This trend could continue, and even accelerate in some interest-rate sensitive sectors, if rates remain elevated and inflation falls further, resulting in higher real interest rates. We feel that the cyclical earnings profiles of these companies could come under pressure amid the slowing economic growth environment.
United States
A series of strong US economic readings dented hopes for a March interest rate cut from the Fed. December non-farm payrolls, retail sales and headline inflation all came in above forecasts, as did Q4 GDP growth – which easily beat estimates at 3.3%. This sent Treasury yields higher in early January, however, yields fell back later as the Fed’s preferred inflation measure dipped below 3% for the first time since 2021. After the month-end policy meeting, Fed Chair Jerome Powell dropped a firm hint that, while rate cuts were “coming into view”, the first one was unlikely to arrive in March as many had been hoping.
Although the developments above caused markets to scale back their expectations of interest-rate cuts slightly, US equities still recorded a positive month. Sentiment was helped by increasing signs that the US economy will manage a ‘soft landing’, as well as a strong start to corporate earnings season.
Communications from the Fed suggest that it has reached the end of the tightening cycle now that the funds rate is comfortably in restrictive territory and the balance sheet is being eroded at an untested pace. While the bank is not yet ready to declare victory over inflation, the recent downtrend in price increases suggests that monetary tightening is having an effect. Inflation and jobs data suggest an increasing likelihood of a ‘soft landing’ for the US economy. As a result, we are gaining confidence in the outlook, especially as a lot of bad news appears to have been priced in by markets already.
China
Chinese equities had a poor January amid continued concern for the country’s economy and property sector. There was disappointment mid-month when the People’s Bank of China left its key lending rate unchanged. Although policymakers promised targeted support for priority areas, markets were hoping for broader stimulus. A cut of 50 bps in the reserve requirement ratio was subsequently pre-announced for 5 February, which could release around CNY1tn (US$140bn) worth of liquidity into the economy.
This followed increasing concern about the heavily indebted property sector, in a month when a Hong Kong court ordered the liquidation of property giant Evergrande. Data from the National Bureau of Statistics (NBS) showed that China’s GDP grew by 5.2% in 2023. However, there were concerns over disinflation, with consumer prices in December falling by 0.3% year on year (the third consecutive negative reading), according to the NBS. Overall, recent economic data has reinforced the case for stimulus.
China’s lacklustre post-Covid recovery, property sector woes and geopolitical tensions have been weighing on the overall market. However, we have noted improving policy visibility, especially regarding stimulus, reforms and regulation. Geopolitical tensions will remain a key risk to monitor; while frictions have eased, the underlying issues have not changed. In terms of US-China relations, recent developments with regard to dialogue have been positive.
Matt Rees, Multi Asset Portfolio Manager, Columbia Threadneedle Investments
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