This note contains an overview of our market views, what we are watching, and our portfolio strategy. Any reference to portfolio positioning relates to our flagship discretionary portfolios. Clients with bespoke or advisory portfolios should consult their Client Advisor for the latest update on your portfolio.
The Fed starts cutting interest rates
Last week, the US Federal Reserve (Fed) decided to cut interest rates by half a percentage point, or 50 basis points (bps), bringing the Fed funds rate in the 4.75-5.00% range. Typically, central banks tend to move in increment of 25 bps. The jumbo rate reduction might reflect the fact that the Fed has a dual mandate of price stability and maximum employment (unlike most other central banks, which solely focus on price stability). US inflation is now lower, and the pace of job creation slower (but positive). So, one could say that the Fed assigned 25 bps to inflation and the other 25 bps to the labour market. In essence, that was the message conveyed by Fed Chair Jerome Powell.
The market reacted to the cut well. The S&P 500 hit a new record last week. The tech-heavy Nasdaq Composite rose too, getting closer to the top it made in July. The US Treasury yield curve steepened (short-dated bond yields fell faster than long-dated ones), but overall bond yields didn’t move much as the fixed income market had anticipated the Fed’s decision. The US dollar depreciated across the board, in line with our view of a moderately weaker dollar on the back of the Fed’s cuts. Gold continued to rise, supported by prospects of lower rates and strong demand from central banks
Does the Fed’s decision impact our positioning?
The short answer is no as the outlook hasn’t materially changed. We remain positioned for a slowing of US growth but no recession (a “soft landing”). That’s why we own slightly more equities relative to our long-term allocation. That said, from here, we are monitoring two plausible paths.
On the one hand, if sentiment stays buoyant and US data doesn’t materially weaken, or even improve, the market will likely reassess the need for further cuts. The market is currently anticipating a few more cuts than the Fed showed in its projections, which could lead to bouts of volatility in the bond market. This is why, tactically, we own fewer US Treasuries relative to our long-term allocation.
On the other hand, if the US labour market were to weaken more significantly, investors might struggle to maintain their optimism. As part of our long-term diversified allocation, we own around three-quarters of our fixed-income exposure in high-quality government bonds and investment grade corporate bonds. These look set to benefit from lower rates and could provide a cushion to performance should growth deteriorate beyond expectations.
What other central banks did (not do) last week
The Bank of England (BoE) decided to keep the Bank rate at 5%. In a way, UK economic data have been relatively resilient, and inflation a bit stickier, and so that might have influenced the decision of the Monetary Policy Committee to leave rates unchanged. With other central banks cutting rates, the pound sterling was one of the best performing currencies last week. With a stronger currency, imported inflation is likely to slow more quickly and, given less competitive exports, this might slow economic growth too. In addition, the 30 October Budget looks set to be restrictive and could weigh further on growth. If that happens, consumer inflation might slow more rapidly than expected. This is one of the reasons why we expect the Bank of England to re-join other central banks and lower rates once again later this year.
The Bank of Japan (BoJ) unanimously decided to hold its policy rate at 0.25%, which mattered for global markets as the surprise increase in rates in August was one of the causes of the volatility spike. The BoJ keeps an upbeat outlook on its domestic economy and the policy statement and message from the BoJ’s Governor suggest it might be raising rates again. But they gave no indication on the timing and extent. The yen depreciated last week despite the weakness of the dollar.
In Norway, Norges Bank also kept the policy rate unchanged at 4.5% and indicated it will hold it there until the end of year. While Norges noted “a weak growth in the Norwegian economy” and “declining inflation”, we think it held rates for two reasons. First, at 2.6%, inflation is still above target, and so are long-term inflation expectations. Second, the Norwegian krone (NOK) has performed poorly for quite some time. Although Norway is a net exporter, mostly oil products that account for around 75% of total exports, it does heavily import big-ticket items such as cars and products for its manufacturing industry. A weak NOK is a headwind to bringing inflation lower.
Central banks action continues this week
This week started with the release of European activity indicators for September. It’s clear that the recovery momentum is faltering in core European countries. Services activity plummeted in France after the boost the country got from the Olympic Games. Germany’s manufacturing activity contracted sharply, while services are barely growing. This means that Germany is likely experiencing a mild technical recession (two consecutive quarters of negative growth). In the UK, the purchasing managers’ indices eased as well, but remain well in expansion territory. Weak growth is likely to weigh on inflation and central banks will continue to cut interest rates. This is the reason we remain overweight in short-dated bonds in the Eurozone (and in UK gilts for GBP portfolios).
We think the Swiss National Bank (Thursday) is likely to deliver a 25bp rate cut, which would bring the policy rate to 1%, as inflation continues to surprise to the downside. The Swiss franc has remained strong in the third quarter, limiting imported inflation. We expect Sweden’s Riksbank (Wednesday) to cut for the third time, too, due to softer growth and subdued inflation. The Swedish krona (SEK) has depreciated less than the NOK this year, as the fall in oil prices (-3% in 2024) is a negative driver for the NOK, but not much of a factor for the SEK.
Lastly, we have some inflation data on Friday. The US personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge is likely to mirror the fall in the consumer price inflation, a development that the US central bank would likely welcome. Inflation in France could have ticked up in August, most likely due to the positive effects of the Olympic Games on the economy. Eurozone inflation is due next week, on Tuesday.
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Information correct as of 23 September 2024.
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