Monthly Market Commentary - October 2024

Central banks took centre stage in Q3, as the Bank of England and Federal Reserve delivered their first interest rate cuts in over four years. Markets generally welcomed the moves with Wall Street and global stock benchmarks hitting fresh all-time highs, although returns for sterling investors were dampened by a sizable currency appreciation as the pound rallied almost 6% against the US dollar to trade at its highest level since early 2022.

The MSCI UK gained 1.7% in the quarter, outperforming the MSCI AC World (0.7%; (all returns in sterling, unless otherwise stated), while bond markets responded positively to rate cuts and the expectation of more to follow, with Gilts returning 2.5%. Sterling’s strength meant UK investors received only marginally positive returns on US equities (MSCI North America 0.2%), while continental European stocks (MSCI Europe ex UK 0.1%) struggled to make much headway due to a less certain political situation following the French election and a softening macro backdrop.

Economies continuing to fare relatively well has allowed rate-setters to keep interest rates firmly in restrictive territory for longer than many expected, providing ongoing downward pressure on inflation. While central bank heads are reticent to declare the battle against inflation won, there is a growing acceptance in their public remarks that concerns in this regard have been substantially alleviated and the focus has shifted more to an apparent aim to not stifle economic growth.

The Bank of England (BoE) lowered rates in August , announcing a 25 basis point reduction to bring the base rate to 5.0%. The news came the day after the Bank of Japan delivered a hawkish hike and the Federal Reserve held its benchmark rate at a 23-year high and the day before a weak US jobs report sparked some consternation that central banks had once more fallen behind the curve and holding rates too high for too long would tip economies into recession.

Technical factors, such as the unwinding of carry trades — based on borrowing in Japan at near-zero interest rates to invest in higher-yielding assets, such as US tech stocks and emerging market currencies — appears to have exacerbated the declines, as the Japanese interest rate increase triggered a sharp yen appreciation and a rush for the exit.

Heading into the Fed’ s September meeting there was a widespread expectation that rates would be lowered, although the size of the move was far from certain. Ultimately, the Fed decided to go with a larger 50 basis point cut lowering the federal funds rate to 4.75%-5.00%, perhaps compensating for their lack of policy easing in the previous month.

As well as boosting sentiment the move also contributed to a significant depreciation in the US dollar in Q3. Economic data also supports the rise in the GBP/USD rate, as the UK has surprised to the upside for much of 2024 whereas the US has come in worse than expected.

Although the BoE and European Central bank (ECB) moved sooner, their reductions were smaller than the Fed’s (25 basis points vs 50 basis points), as the US central bank played catch up. Furthermore, the US is expected to lower rates faster going forward than European peers, maintaining downward pressure on the US dollar. Markets are pricing in another 50 basis points of Fed cuts before year end and a Fed funds rate below 3% by the end of 2025.

It appears now that central bankers are seeking to move policy towards the neutral rate, where it is not stimulative nor restrictive. The question is, what level is that? Fed chair Powell recently stated the neutral rate is “only known by its works”, while the median estimate among FOMC members is 2.9%, although they expect a slower move than current market pricing, not reaching this point until 2026.

Conclusion

UK, US and Eurozone central banks are now all in interest rate cutting cycles, seemingly seeking to lower benchmark rates to a neutral level. This level is not known precisely, but consensus estimates currently put it around the 3% mark. Although rates are expected to fall, a return to the near-zero interest rate policy prevalent since 2008 remains unlikely, with an emerging economic consensus that the neutral rate has risen in recent years due to expansionary fiscal and monetary policies, ageing populations and deglobalisation. Corporate earnings continue to grow across most sectors and regions, underpinning our positive outlook for equities.

Stock markets remain on track for another good year despite the summer bout of volatility with the MSCI AC World and MSCI North America benchmarks sitting on double-digit gains and the MSCI UK not far behind. Bond markets have recently been boosted by central bank actions and inflation falling back closer to target. We remain positive on the overall backdrop for bonds but have moved to a neutral duration stance ahead of the US election as potential deficit concerns could cause some near-term weakness.

Given the backdrop, we currently have an overweight to both equities and fixed income asset classes, funded by and underweight to alternatives such as hedge funds.