January has been remarkably jolly. Though there is a day and a half to go until the month end, and there is many a slip betwixt the cup and the lip (as my jumpers testify), markets have had a renewed confidence. The MSCI World Index has risen by over 6% since the turn of the year, led by a rebound in the previously much-derided US large technology companies. Bond markets have also been well behaved and yields have fallen slightly over the course of the month. This week, however, brings the toughest test yet.
Over the course of Wednesday evening and Thursday lunchtime, the Federal Reserve, the European Central Bank and the Bank of England will all raise interest rates. The recoveries in equity markets, and to some extent in bonds, are primarily predicated on all three Central Banks being close to calling time on further increases in the cost of borrowing. There is sound logic behind this – inflation is already starting to fall and economies seem to be slowing down – but it is by no means certain. Markets will scrutinise every comma, semi colon and change of phrasing that the three Banks publish for clues as to whether their bet on a near-term peak of the cycle is right. The Banks, of course, know this and will happily play the game. It is a game of double and triple bluff, which usually ends up going round in circles.
It is a safe bet to predict that the Banks will say that it is far too soon to start to relax about inflation, that they will stay vigilant and that they will do whatever is required to bring inflation back to target. This is the lowest possible bar: the Banks say this at every meeting, no matter whether inflation is above or below target. It is a truism that the Banks will predict inflation returning to target, to do otherwise would be admitting that they are out of control. And this, of course, is where they necessarily are. To have, or to have had, the inflation rates that we have seen over the past year is ample proof that the Banks got this particular cycle spectacularly wrong.
Markets are therefore banking on the Central Banks not making an even bigger mess of things on the way back down. In fairness, it is what is commonly referred to as ‘a tough gig’. If we are to predict where inflation may be in, say, 18 months’ time, we could see deflation, or we could still have rates of 5% or more. Forecasting is a game for mugs at the best of times, and rarely more so than now.
We began by saying that the large US technology stocks were responsible for much of the recovery in global equity markets. This is also going to be tested over the next five days. Last week Microsoft’s quarterly update was largely uneventful: things have slowed down, but not to an extent that should cause lost sleep. On Thursday this week, we have to navigate the updates from Apple, Alphabet and Amazon.com. Their stock prices are up by 12%, 12% and 20% respectively so far this year, but are still a long way below their 2021 and early 2022 high spots. These quarterly earnings, and the projections for the rest of the year, have taken on an undue importance.
It is rare to have so many market-sensitive events in a single week. It is very unlikely that all the messages will be consistent. And if they were, we would treat them with considerable mistrust. Economies are inconsistent and reports from the front-line of business are likewise. January has been pleasantly benign, we should not be surprised if February proves to be a different challenge. This week strews a hand of banana skins in investors’ way; it would be a surprise if at least one of these did not cause a bruised coccyx.
Finally, well done to everyone who knew that the only spoken word in Silent Movie was ‘non’, said by Marcel Marceau (to refuse an invitation to appear in the film). We return to popular and/or ridiculous lyrics this week: “we are stardust, we are golden, we are billion-year-old carbon, and we’ve got to get ourselves back to the garden”.
Jim Wood-Smith – Market Commentator and Head of Climate Transition
FPC834
All charts and data sourced from FactSet
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