February Market Update: Mixed Signals

What’s moving markets

Economic data and central bank decisions came in thick and fast in January, swinging both stock and bond markets.

Firstly, as predicted, the US Federal Reserve maintained the FED funds rate at 5.25-5.50%. Despite keeping rates high, the accompanying statement didn’t mention the previous tightening bias. However, it did say that the committee will reduce rates only when they have further confidence that inflation is moving down. This may be a reaction to the reacceleration in the headline annual inflation rate, rising to 3.4% in December from 3.1% in the month prior, as energy costs slowed. The US economy remains strong though, with Q4 GDP growth rising at a 3.3% annualised rate. The FED will be wary of cutting too soon if inflation does rear its ugly head again. 

In the UK, the BoE followed suit and held interest rates at 5.25%, despite a three-way split where two members actually voted to increase rates! This probably had something to do with the unexpected increase in UK inflation which, year on year, rose to 4% in December - up from 3.9% in November. Despite this rise, April should bring another significant drop in the year-on-year numbers, as the next big fall in energy prices comes into the figures. Wage growth also eased to 6.6% in the three months to November, helping to keep the prospect of a May or June rate cut from the BoE alive. 

Despite a softening of rhetoric from the FED and the BoE, there was no such talk from the ECB who held rates at the 22-year high of 4.5%. ECB President Christine Lagarde said that officials unanimously agreed it was too early to be discussing rate cuts, despite no growth in the Euro Area economy in the fourth quarter following a 0.1% contraction in the third. The German economy (the largest) contracted by 0.3%, showing the strain the Euro Area is under. Year-on-year inflation in the Eurozone rose to 2.9% in December from 2.4% in November. 

Although China is currently struggling with many issues, its economy expanded by 5.2% in the fourth quarter of 2023, up from 4.9% in the third. The Peoples’ Bank of China said it will cut the reserve requirement ratio for banks in early February, which will inject liquidity into Chinese markets. The Chinese are still easing but have their own unique set of circumstances to navigate compared to other developed and emerging economies.
 
In its January meeting, the Bank of Japan kept its key short-term interest rate unchanged at -0.1% and the 10-year bond yield at around 0%. It also cut its CPI projection for 2024 to 2.4% to reflect declining oil prices. 

Asset class implications

In a data heavy month, we saw just how sensitive Government bonds are to interest rate expectations. The UK 10-year gilt started the year at around a 3.6% yield, before fluctuating upwards on surprising inflation data to north of 4% and ending the month at around 3.75%, swinging bond prices. The FTSE Actuaries UK Conventional Gilts All Stocks index declined by 2.2% in January as a result of these fluctuations and the lack of certainty of when the BoE will cut rates. Corporates and High Yield bonds fared better, eking out returns as spreads tightened during the month. 

The US continues to defy gravity, thanks to the enthusiasm surrounding the AI revolution and optimism around a soft landing. The S&P 500 breached multiple record highs during the month, led by the ‘Magnificent 7’ stocks. Performance stalled slightly towards the end of the month as uncertainty around imminent rate cuts by the FED took hold.

China continues to lag, as its domestic economy struggles with the property sector slowdown and the impact on wider consumer confidence. Despite the announcement of further stimulus from the PBOC, this was not enough to ‘stop the bleed’ and this consequently dragged down the FTSE Emerging and FTSE Asia Pacific ex Japan indexes.

Following an exciting year-end rally in December it was always going to be a tough ask for January to bring more of the same. Investors have seen mixed results. A we firmly enter 2024, it appears the days of benign inflation and artificially low interest rates are likely gone for good. 

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