The big event last week was the Federal Reserve’s decision to kick off the US rate-cutting cycle with a bumper 0.5% cut, rather than the more normal 0.25%. The meetings of the Bank of England and Bank of Japan, where rates were left unchanged, were a mere side-show.
The Fed move was greeted favourably by markets with global equities rising 1.6% the following day and ending the week up 1.3% in local currency terms. US equities are now slightly above their all time high in July while global equities are bang in line.
In sterling terms, the gains were rather more muted with a strengthening in the pound to $1.33 against a weak dollar limiting the rise in global equities to 0.3%. The US fared best of the developed markets with a gain of 0.6% whereas the UK was down 0.5%. But the best performer turned out to be China which gained 3.4%. It reversed some of its recent poor performance as hopes grew of a stimulus package to support growth which is in danger of missing this year’s 5% target.
Bond markets had already to some extent moved ahead of the event to price in a 0.5% cut by the Fed. And government bond yields actually ended the week flat or slightly higher, leading to Treasuries and Gilts losing 0.5-1.0% over the week.
As ever, the Fed’s commentary surrounding its move was almost as important as the cut itself. The Fed usually only cuts rates by as much as 0.5% when it is staring a recession in the face and Chair Powell did his best to argue that this was not the case this time. He emphasised that the economy remains strong and the cut was just a reflection of greater confidence in inflation returning to 2% and the desire to head off any further weakening in the labour market.
The Fed now sees rates falling from their current 4.75-5.0% to 4.4% by year-end and to 3.4% by end-2025. That said, it continued to emphasise the uncertainty over the speed and extent of the forthcoming decline.
As for the Bank of England, its decision to leave rates unchanged at 5.0% was no big surprise and the prospect is for rates to decline rather more slowly here than in the US. Governor Bailey said the Bank should be able to reduce rates gradually over time but it needs to be careful not to cut too fast or by too much.
Its caution followed last week’s inflation numbers which were a bit higher than expected. Whilst the headline rate was unchanged at 2.2%, the core rate rose to 3.6% from 3.3% and services inflation picked up to 5.6% – albeit largely due to a surge in airfares which are volatile.
Although the market sees UK rates being reduced by 0.25% in both November and December, it expects them still to be at 3.7% by next summer. By contrast, its rather optimistic view is that US rates will fall faster than the Fed is projecting and be back down to 3.0% by then.
As we highlighted last week, Fed easing is normally a positive backdrop for equities unless there is a recession looming which we continue to think is unlikely. We believe equities are well placed to continue their upward trend although the scope for further gains is largest in the cheaper markets outside the US. Gains are likely to be constrained in the US, other than in inexpensive area such as small and mid-cap, by high valuation levels.
The price-earnings ratio of the US is once again as much as 60% higher than other markets. With doubts now emerging over whether the massive AI-related investments of the Magnificent Seven will be as profitable as they hope, such high valuations are becoming more questionable. The UK and quite a few emerging markets, by contrast, remain downright cheap and look attractive.
This coming week is relatively quiet on the data front. Business confidence numbers this morning showed optimism remaining comfortably in expansionary territory in the UK but made gloomy reading for Europe, where sentiment fell further into recession territory. In the US, the main focus will be the release of the Fed’s favoured inflation measure on Friday.
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