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The European Central Bank looks set to cut rates this week
Markets & Investment Update 3 June 2024
This note contains an overview of our market views, what we are watching, and our portfolio strategy. These developments may not mean changes to your portfolio so please contact your Client Advisor for the latest update on your portfolio.
At a glance
The ECB is likely to cut interest rates this Thursday Inflation in the Eurozone rose for the first time this year, adding to worries that the inflation-easing trend may have come to a halt therefore limiting the European Central Bank’s (ECB) ability to cut interest rates. We disagree: we think that inflation progress is just slowing. One of our 2024 outlook views was that inflation would slow to just above central banks’ targets. This is what’s happening in the Eurozone, and we think the ECB will cut interest rates later this week (Thursday). Any upcoming ECB rate cuts are likely to be a tailwind for consumption and investment and, therefore, economic growth. We’ve recently added to European equities to our tactical asset allocation, given the better growth prospects.
One good inflation data point is not enough for the Fed The US Federal Reserve’s (Fed) preferred inflation measure came in line with economists’ expectations, at 2.7% compared to a year ago and 0.2% compared to the previous month. However, given the Fed’s recent communication, one data point is not enough to ease its inflation worries. Earlier last week, the Fed’s Beige Book (which gathers information on current economic conditions from the central bank's 12 districts across the US) revealed the Fed was concerned about the slowing in inflation progress. This sent equities lower amidst some profit-taking after US stocks had made record highs in the previous week. We think it’s unlikely that the Fed will start cutting rates next week, but last week’s inflation data is modestly supportive of a September rate cut. Overall, inflation is much lower than it was 18 months ago, and US growth has moderated. So, we think the Fed has room cut to interest rates once or twice in 2024, which would be a positive development for markets. Investors will likely continue to focus on key data: expectations for the employment report (Friday) have adjusted lower, below the 200,000 mark, reducing the odds of a meaningful downside surprise that could spur market volatility.
Turning to election mode in Europe This week, from Thursday, the elections for the European Parliament are held – with the first results to appear late Sunday. Unlike the US election, it won’t probably cause major moves in markets, the euro and European stocks. The opinion polls suggest the current centrist coalition will retain a majority, but the far-right could gain some grounds. This could have implications for some legislation. For example, some of the key reforms of the EU Green Deal, the EU budget and debt issuance, trade policies and investment, and geopolitics. Another key theme of our 2024 outlook was that we live in a world that’s more fragmented along geopolitical lines. This was one of the reasons why we added a broad commodity exposure to our portfolios at the start of the year, which could mitigate the risks of geopolitical uncertainty on markets. The Bloomberg Commodity Index is up 8% in 2024. How we’re positioned in flagship portfolios
Tilting from bonds to equities in Europe The outlook is improving in Europe and interest rate cuts are likely on the horizon. In May, we decided to add exposure to Europe ex UK equities. We financed the purchase by slightly reducing our European investment grade bond exposure, where the differential with ‘risk-free’ government bonds, also known as ‘spread’, has tightened further. Elsewhere, we’re keeping our overweight exposure to global small-cap equities as valuations and the economic backdrop are supportive. And our exposure to high-yield credit is lower than normal, as we don’t think valuations compensate adequately for the risks.
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Information correct as of 3 June 2024.
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