Weekly comment: Markets rise on summer rate cut expectations

Market overview – Alan McIntosh, Chief Investment Strategist

Stock and bond markets enjoyed a good week last time out, with the MSCI All Country World Index advancing 1.8% — up 7.9% year-to-date — as bond yields fell on dovish central bank updates.

The Bank of England (BoE) and Federal Reserve (Fed) both opened the door to interest rate reductions in the summer following their latest policy decisions and derivatives markets are now pricing a roughly 85% chance that each policymaker delivers a first cut in June.

Although the BoE base rate was kept at 5.25% for the fifth consecutive policy meeting there was a notable change in the voting pattern of rate setters as two previously hawkish members dropped their calls for an increase. This left the panel with an 8-1 split, as a solitary member voted for an immediate rate cut.

The announcement came the day after it was revealed UK inflation fell to its lowest rate since 2021, with the consumer price index (CPI) year-on-year falling to 3.4% in February from 4.0% in January. The reading was also below consensus forecasts among economists. The data and central bank update helped UK stocks outperform, rising 2.7% on the week to take year-to-date gains to 3.6%. UK bond yields fell on the week with the 10-year gilt yield falling back through the 4% level to close at 3.93%. The pound depreciated against the US dollar, dropping to 1.26.

Fed looks past rise in inflation

It was a similar story in the US as the Fed also kept interest rates unchanged. The market focused on dovish aspects of the update, particularly chair Jerome Powell’s lack of concern regarding recent increases in inflation data, dismissing the gains as largely due to seasonal factors. The message from across the pond was perhaps slightly less dovish than that from the BoE, as demonstrated by the decline in the sterling to US dollar exchange rate. Nonetheless, Wall Street responded positively and US stock benchmarks chalked up solid weekly gains of 2.3%, taking the 2024 rise to 10.1%. 

Coming into the year there were high hopes for substantial interest rate cuts on both sides of the Atlantic and it’s a sign of the markets’ underlying strength that stocks have continued to rally despite these expectations being pared back significantly. While interest rate reductions are still expected, markets are currently pricing three or four 25 basis point cuts this year, considerably less than the six or seven seen in early January.

Investors are seemingly looking through the decrease in the size of expected central bank support and focusing more on continued resilience in economic data, particularly in labour markets. US stock indices snapped a two-week losing streak to post new record highs and are set to round off the first quarter with a sizable gain.

Japanese equities have also enjoyed a bright Q1, and stocks in Tokyo rallied over 5% last week to extend the double-digit rally for 2024. The Bank of Japan (BoJ) raised its policy rate to 0.10%, ending the era of negative rates which began in 2016. The increase was historic, the first time since 2007 the BoJ has raised rates but the news was taken in the market’s stride with equities rallying and the currency depreciating, suggesting that it was seen less hawkish than it may have been.

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