Weekly house view | Rates higher for longer... but not forever

The US Federal Reserve surprised markets last week with a remarkable policy pivot, signalling that it had started discussing interest rate cuts in a dovish message that lifted bonds and equities. The message came despite Fed Chair Jay Powell saying just two weeks earlier that it was too early to think about when policy might ease. The median Fed official is now projecting three quarter point cuts next year – a scenario that could help President Joe Biden in an election year. Fed officials have also downgraded their inflation forecasts for this year and next, and markets are now pricing the first cut in March. The policy pivot pushed the yield on 10-year Treasuries below 4%. We are long US duration and like US investment grade bonds. In stocks, the S&P500 had its seventh consecutive positive week, the Russell 2000 index of more rate-sensitive smaller caps surged 5.6% to a 52-week high, and the VIX index of implied volatility fell. Money markets saw the first outflow of funds since October, a shift that fits with our theme of moving from cash to quality fixed-income investments. A large US health insurer also pulled out of a merger and announced plans to increase stock repurchases, fitting with our preference for investing in companies that can return money to shareholders.

Underlining our point that accidents can happen in markets, Argentina’s new government devalued its currency by 50% and embarked on austerity measures to tackle an economic crisis. In Europe, Norway’s central bank delivered a surprise rate hike but otherwise policymakers were cautious. The European Central Bank did not discuss rate cuts at its meeting, ECB President Christine Lagarde said. Our baseline scenario has been for the ECB to start cutting rates in June, with a risk of an earlier move in April, but a lot will depend on the Fed. We are long European duration and European investment grade bonds.

In China, economic indicators point to policy-supported growth. However, the country continues to battle deflation as a housing slump has suppressed demand and prices. On Friday, the People’s Bank of China injected a record amount of liquidity into the banking system. We prefer to invest in broader emerging market equities. This week, the Bank of Japan meets on Tuesday and we expect no policy change. We believe the BoJ will tread carefully in coming months but we are staying underweight Japanese government bonds as pressures keep building on the central bank to exit yield curve control and negative rates policy later in 2024.

After an eventful year, we wish you the very best for this holiday season and for 2024.