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Investors prep for June rate cuts

market snapshot

23 February 2024 |
Active ESGMacro
Stronger-than-expected US data this year has led markets to reprice rate expectations, with the first full cut from the ECB and the Fed now forecast for June 2024.

Fast reading

  • Stock markets rallied this week following Nvidia’s stellar Q4 results which suggest the outperformance of the ‘Magnificent Seven’ US blue-chips may have further to run.
  • Breadth in the S&P 500 remains an issue, with half the index down this year despite the rally, but strong fourth quarter earnings in many sectors suggests other stocks may rise.

When will central banks begin to cut rates?

The US Federal Reserve (the Fed) and the European Central Bank (ECB) both held rates steady in January, awaiting more positive data before pulling the trigger, but delaying too long obviously carries risks.

“After stronger-than-expected US data this year, markets have repriced rate expectations and are now factoring in the first full cut from the ECB and the Fed around June 2024,” says Orla Garvey, Senior Portfolio Manager – Fixed Income, Federated Hermes Limited.

An almost identical amount of cumulative cuts from the two central banks (169bps) are now priced in by markets by the end of 2025. The distribution of the cuts, however, is slightly different, with the ECB expected to cut more than the Fed this year with the Fed catching up in 2025, Garvey adds.

“A few things stand out to us at this juncture,” Garvey continues. “While we have started to see growing divergence between market pricing of other central banks; the Fed and the ECB remain remarkably close together.”

The Fed and the ECB remain remarkably close together

US data is looking broadly strong and surprising to the upside, while the eurozone is in a structurally weaker position given the stagnant growth outlook and exposure to China weakness, she adds.

“The ECB is signalling that it wants to see more evidence of loosening in labour markets and Q1 wage-setting agreements before cutting rates and while there may be some short-term support for growth given an improving real wage outlook and some optimism in survey indicators; tighter-for-longer ECB policy is more likely to prove a drag on growth and result in looser monetary policy in the future,” Garvey says.

“The Fed on the other hand has displayed some desire to cut rates to avoid running real policy rates at levels that are restrictive given inflation is moving towards target,” she continues. “However the persistently strong data this year has raised uncertainty around what the appropriate level of rates should be or what R-star1 – the real neutral rate of interest – actually is. The clear risk is that central banks deem the R-star to be higher than previously thought and, therefore, more cuts would need to be removed from this year and next.”

The S&P’s ‘other 493’

In markets, equities rallied on Thursday following chipmaker Nvidia’s stellar Q4 results boosted technology groups as indices in Asia and Europe rallied. Japan’s Nikkei 225 Index closed up 2.19% on Thursday while the pan-European Euro Stoxx 50 ended the day up 1.69%2.

The results suggest the rally led by the so-called ‘Magnificent Seven’ of US blue-chips – Apple, Meta, Amazon, Alphabet, Nvidia, Microsoft and Tesla – may have further to run. A Federated Hermes’ poll conducted on Linkedin last week suggested that 71% of investors felt the Magnificent Seven were overvalued.

Figure 1: Magnificent Seven vs ‘S&P 493’

“[Lack of] breadth continues to haunt the market, with half of the S&P 500 down for the year despite the rally to yet another record high this week,” says Linda Duessel, Senior Equity Strategist at Federated Hermes. “Maybe there’s a glimmer of hope there, with FactSet saying that fourth quarter earnings look set to grow faster for the ‘S&P 493’ than for the Magnificent Seven.”

“Bond fund flows have been strong so far this year – about U$9bn  per week, which is well above average,” Duessel continues. Bonds and stocks haven’t been this negatively correlated in a quarter century and the biggest upside and downside risk to equities comes from the bond market, she adds.

The 10-year US Treasury yield traded well above the 4% mark (4.3% at 16:30 GMT on Thursday3) a level that has spelled trouble for the equity market in recent months, Duessel adds.

For further insights on fixed income, please see: 360°, Q1 2024

1 R-star is the real neutral rate of interest that equilibrates the economy in the long run.

2 Bloomberg as at 22 February

3 Ibid.


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