What will rate cuts mean for markets?
Global equities (MSCI Index) have risen by 16% since late October. This was driven by a significant change in market expectations around interest rates, as inflation has fallen faster than expected. The Federal Reserve (Fed) boosted markets further by signalling large rate cuts in its mid-December policy projections for 2024, with other central banks expected to follow suit. As investors, it is important to look at why the Fed may cut rates. If the cuts come about because growth is falling faster than inflation, 2024 could still come with headwinds for equities and other risky assets. However, for the time being there are good reasons to celebrate the falling cost of capital, not least because of the impact on the cost-of-living crisis.
What does COP28 mean for investors?
Futures contracts tied to the EU’s emissions trading scheme, the largest carbon trading market globally, have been under pressure since the start of the year and are now close to the lowest level since late 2022. The decline was driven by market disappointment with the outcome of the COP28 summit, even though governments made additional climate commitments. The downward trend began late last year when a draft agreement omitted references to the “phasing out” of fossil fuels. However, there were positives. Nearly every country worldwide agreed to move away from fossil fuels during this decisive decade. The agreement also acknowledged that limiting global warming to 1.5°C would require a nearly 50% reduction in emissions by 2030.
A year of elections
One big theme of 2024 will be elections, with the US, UK and India set to go to the polls this year. In the UK we have seen more political stability, with only one Prime Minister over the last 12 months, despite wide-ranging economic and political challenges. The UK election probably won’t alter the trajectory of global financial markets, but it could well have an impact on UK assets and sterling. Meanwhile, investors will be very focused on what the outcome of the US election will mean for America’s debt trajectory, with significant implications for global bond markets. The result will also have a significant impact on geopolitics, from America’s relations with China to war in Ukraine and Israel.
Our positioning
To guide our transition to a more positive stance on equities, we have been monitoring four key indicators. The most important of these is a peak in interest rates. It now looks increasingly likely that this has been reached. Inflation continues to fall, with the latest US readings at the lowest level in over two years. US wage increases, a key driver of inflation, appear to have at least plateaued as unemployment slowly ticks up. Even if the Fed does not pivot to rate cuts quite as soon as markets currently expect a peak in interest rates is in itself supportive for stock markets. As a result, we have been increasing our exposure to equities across different risk profiles. The recent equity purchases have in part been funded by reducing alternatives and cash. Within Bonds, we remain slightly overweight given they now provide attractive levels of income and could also help to protect portfolios if economic growth slows significantly, and central banks cut interest rates to support growth.
High levels of inflation in the UK have made meeting inflation plus return targets more challenging in the shorter term. Despite this, we remain confident in the ability to meet inflation-plus targets over the longer term.
Key
🟢 Positive
⚪ Neutral
🔴 Negative
Outlook
| Economics | Global growth continues to be resilient, driven by consumer demand in developed markets. However, the full impact of rate increases to date have not been felt and risks remain.We continue to expect headline measures of inflation to moderate, although core inflation remains above central bank targets.Interest rates have likely peaked but hopes of imminent rate cuts may be premature. |
| Valuations | After rallying strongly towards the end of 2023, global shares look somewhat expensive compared to their long-term average.Government bonds also rallied late in 2023 and yields fell. However, bonds still offer relatively attractive levels of income and could help to protect portfolios if economic growth slows more meaningfully.Valuations of both equities and credit remain vulnerable to a meaningful deterioration in corporate earnings. |
| Sentiment | Investor sentiment improved significantly in the final months of 2023.Consumer confidence remains weak compared to historic levels, particularly outside the US.Further rises in bond yields or oil prices, and a potential government shutdown in the US, could add to market concerns in the near term. |
| Risks | Persistently elevated levels of inflation, which would warrant continued hawkish central bank policy.Escalation in geopolitical tension e.g. Middle East, Russia/Ukraine, US/China.Labour market weakness and falling consumer demand could challenge the developed market growth outlook.Potential spillover effect from slowing growth in China on the global economy. |
Asset Classes
| Asset classes | Current positioning | Current views |
| Equities | ⚪ | Falling inflation and a peak in interest rates have prompted us to add to equities. However, elevated valuations and buoyant market sentiment mean we have a neutral stance entering 2024. |
| Bonds | 🟢 | Overweight fixed income given more attractive valuations and defensive characteristics. |
| Alternatives | ⚪ | Higher interest rates require greater selectivity in alternatives. Commodities remain attractive as an inflation hedge, but we are neutral on alternatives overall. |
| Cash | 🔴 | Cash has a poor track record of preserving real wealth over the long term. However, available rates are higher than in the past and holding some cash allows us to take advantage of tactical opportunities quickly. |
Terms
Spread: the difference in yield between a non-government and government fixed income security.
Duration: approximate percentage change in the price of a bond for a 1% change in yield.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
