Markets last Week
Summary
- Financial markets globally saw positive returns from equities and bonds
- The Federal Open Market Committee (FOMC) left interest rates in the US unchanged, with Chairman Powell reiterating a desire to lower rates when data permits, leading to a drop in government bond yields, particularly at the short end of the curve
- Weakness in the labour market emerged as payrolls data was significantly weaker than anticipated on Friday. This resulted in a rally in the equity market and a further fall in bond yields due to the implications for easier monetary policy
- US consumer-facing sectors encountered difficulties due to a weakened consumer base, while productivity measures have bolstered operating margins this earnings season
- The eurozone saw benign inflation data, reinforcing expectations for a June rate cut
- UK equities performed well, driven by a rotation towards value stocks, further supported by rising yields and a softer Pound
- Commodities faced a downturn, especially oil, due to easing geopolitical tensions and increased US oil inventories
- This week the Bank of England (BoE) rate decision is due on Thursday. The BoE is unlikely to cut rates. The focus will be on forward guidance and on the vote split of the Monetary Policy Committee as some anticipate a more dovish tilt
- On Friday, UK Gross Domestic Product (GDP) data is due as economists anticipate the economy rebounded in the first quarter from the extremely mild recession at the end of last year.
Analysis
It was another solid week for financial markets, with equities and bonds in most regions delivering positive returns. The main event was the FOMC meeting in the US in which senior Federal Reserve (Fed) officials set interest rate policy. Despite anticipation for a more hawkish stance from Chairman Powell, monetary policy went unchanged, and Powell reiterated a desire to lower rates and a reluctance towards further hikes. As a result, government bond yields dropped, particularly at the front end of the yield curve.
FOMC officials continue to await better inflation data to support interest rate cuts. The market took this as a positive as there was a fear ahead of the meeting that the Fed would pivot more aggressively, even putting the possibility of a hike back on the table. The upcoming election adds another layer of complexity as any policy changes made after the June meeting put the Fed at risk of being accused of being politically motivated.
Although US economic activity appears healthy, signs of weakness in the labour market began to show. A particularly soft payrolls report on Friday spurred an equity and bond market rally on the basis that it increases the likelihood of a rate cut. Over the week, US equities rose 0.5% in USD terms and the Two-year US Treasury Yield fell 0.16%.
April’s non-farm payrolls came in much lower than expected with 175k new jobs compared with an expected 240k. Although this is currently seen as a positive as it justifies the Fed’s easing bias in the face of sticky inflation, a cooling labour market also raises the risk of slowing the consumer more and there are reports already hinting at a slowdown in consumer sectors.
Consumer sectors have cautioned about the challenging landscape for lower-income households in the US. Consumer stocks less dependent on the US market, particularly those with significant exposure to emerging markets, have performed more favourably in the current earnings cycle.
In response to high costs across the supply chain, including wage inflation, companies have embarked on numerous productivity and cost-saving measures to enhance their profit margins. These initiatives have broadly fortified operating margins throughout this quarter, reflecting an overarching theme of margin improvement in the current earnings cycle. This trend bodes well for future earnings potential, providing that economic growth remains resilient. In our view, as long as recession risks remain low and rate hikes do not become part of the narrative, risk appetite should remain buoyant.
In the eurozone, relatively benign inflation data reinforced expectations for a June rate cut. The futures market is now pricing in a 95% probability of a cut in June. Economic growth in the first quarter surprised on the upside, recovering from negative territory in the final quarter of last year. The European Central Bank (ECB) remains watchful of wage pressures but is hinting at further rate cuts in 2024. The ECB will need to be careful of creating too much of an interest rate differential – cutting too much ahead of the US – as this could cause volatility in the single currency.
UK equities performed well last week with the FTSE All Share rising 1%. There was a rotation from European stocks into the more value oriented, and cheaper, UK market, with European equities falling 1.5% in GBP terms. This rotation was underpinned by the revival of lagging benchmarks, with UK and Chinese stocks emerging as some of the best performers globally. Value stocks took the lead, with sectors such as energy, mining, and banks significantly outperforming. The UK benefitted notably from exposure to these areas, with mining M&A activity providing additional support to the sector. Rising yields, high oil prices, and a softer Pound further bolstered the FTSE.
It was a bad week for commodities as oil gave back almost half of its gains for the year so far. The catalyst may have been geopolitical as tensions between Israel and Iran seem to have eased, at least for now. The significant build in oil inventories in the US as well as strong and stable production were likely another driving factor. It’s probable that the Biden administration will do everything they can to keep oil prices low ahead of the election in November. Reescalation of geopolitical tensions however could quickly reverse the downward trend from last week.
The week ahead
Thursday: BoE rate decision
Our thoughts: The BoE has become more dovish this year and inflation data has not been as sticky as in the US. Also, the UK economy has not been as resilient as the US, making a cut more credible. The BoE are not likely to cut rates at this meeting and investors will be looking for evidence of when the first cut is likely to come and whether the market is correct in pricing in two cuts for this year. The vote split on the committee will also be of particular interest, as if the recent momentum continues, there could be a further shift in favour of a cut.
Friday: UK GDP
Our thoughts: Economic growth in the UK is expected to have rebounded from the extremely mild recession in the second half of last year. Economists anticipate that the economy grew 0.4% in the first quarter taking year-on-year growth to 0%. Although the data is unlikely to be particularly impressive, at least it shows that the UK is on a recovery path from a period of high inflation and interest rates.
Friday: US University of Michigan Consumer Sentiment survey
Our thoughts: US consumer sentiment is expected to drop further in early May as sticky inflation continues as a source of concern. The recent weakening of the labour market is likely to add to these woes.
