Weekly house view | Connecting the Dots
Markets will be on tenterhooks this week for the release of the Federal Reserve’s preferred inflation measure, core PCE, on Friday for indications as to whether the Fed has finished hiking interest rates. Another driver for markets is the risk of a government shutdown, with US lawmakers saying time is running out for a deal to resolve a budgetary impasse. Last week, the Fed left interest rates unchanged but surprised markets with a more hawkish “dot plot” for 2024. Members of the Federal Open Market Committee (FOMC) now expect rates to fall by 50 bps next year instead of 100 bps previously. That is consistent with our ‘higher for longer’ view. After the Fed’s unexpectedly hawkish stance, the 10-year yield briefly hit 4.5% (the highest since 2007) before easing slightly. The Fed also revised up its 2023 growth projections from 1.0% to 2.1%, referencing the tight labour market. In equities, we are underweight small caps, which are more sensitive to rates as they have a higher share of floating debt. Small caps and the Nasdaq both lost more than 3% on the week. Cyclicals have stopped outperforming defensives as markets worry about the impact of higher rates for longer.
In Europe, the Bank of England left its policy rate unchanged at 5.25% but said policy would need to be “sufficiently restrictive for sufficiently long”. It decided to accelerate its quantitative tightening. The Swiss National Bank kept its policy rate unchanged and said tightening over recent quarters is dampening inflation. The surprise SNB decision weakened the Swiss franc, which lost more than 1% versus the dollar. We are negative the Swiss currency. The Dutch parliament approved a proposal to raise taxes on banks, hitting shares in the country’s largest lenders.
The dispute between Armenia and oil-rich Azerbaijan over the Nagorno-Karabakh region added to anxiety in the tight oil market last week. A ceasefire was brokered but the latest tensions are another example of geopolitics complicating the outlook for markets. Oil prices remain well supported by production cuts, including a reduction in Russian exports. We maintain our $95 Brent year-end target. In another example of the increasingly fraught geopolitical environment, a diplomatic dispute between India and Canada escalated. In Brazil, the central bank cut its policy rate by 50bps for the second time. Latin American countries led the Fed’s hiking cycle by 12-18 months and the same is now happening on the easing front. We are overweight EM bonds in local currency.