Central bank elves boost 2023 Santa…

Source: Tatton Investment Management, "Tatton Weekly" 15/12/2023

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Central bank elves boost 2023 Santa rally

The full edition of this Tatton Weekly presents our outlook for 2024, inevitably, much of what we write depends on the starting point and this week has moved that starting point markedly. This doesn’t make writing the outlook any easier, but at least the timing of publication means we do not need to revise our outlook already.

Looking back to a year ago, the introduction article to our 2023 outlook was titled: ‘Central bank scrooges cancel Santa rally’. One year can be a long time, and this year provided a very welcome Santa rally to end it. This means that globally invested, diversified investment portfolios like the ones we manage for clients, should have once again, by and large, outperformed prevailing cash rates and consumer price inflation. Higher risk, equity focused portfolios in some instances should have returned even twice that.

The gifts Santa brought markets were crafted by the central bank elves. Well, maybe Andrew Bailey and Christine Lagarde were less involved than Jerome Powell but at least they didn’t try to break bits off the gifts. On Wednesday, the US Federal Reserve (Fed) did not move rates, but the market reacted almost as if it had announced a cut. Expectations of where rates will be across next year dropped sharply, with the first 0.25% rate cut now seen as underway by May and then rates being cut by 0.25% five or six times in total in 2024. Last Friday, the first cut was predicted for June and three/four cuts for the year.

The shift in tone of Jerome Powell’s press conference comments after each of the last three Federal Open Market Committee (FOMC) rate decision meetings has been the spur for changing market perceptions, given there have been no actual interest rate changes. We note that his authority with markets has increased, with investors lately hanging on his words almost as much as they did with the legendary Alan Greenspan in the 1990s.

Powell spoke of declining inflation pressures and, notably, an employment market moving into balance, which was completely unexpected. Given the unemployment rate had shown a fall from October’s 3.9% to 3.7% in November, this was an important assertion. Only at the beginning of the year, Powell had talked of the non-inflationary level of unemployment rate being 4.5%, so clearly, the FOMC’s view of what level constitutes ‘balance’ must have changed.

It is also interesting to note how the trading interlinkages of money markets mean that (for the time being) the European Central Bank (ECB) and the Bank of England (BoE) currently have less impact on domestic interest rate expectations than does the Fed. Both held meetings on Thursday and, despite no rate move and only marginal differences to the October/November meeting narratives, rate expectations dropped before the meetings and stayed there as well.

Andrew Bailey did allude to “making progress” on the inflation front. Not surprising, since growth is anaemic for the UK as a whole, and November’s monthly growth was -0.3% which may well mean this year’s last quarter will show a small contraction. However, we continue to see a disparity between sectors; services remain supported, but manufacturing is worsening again, according to the CIPS/S&P Global purchasing manager index (PMI) reports. These showed the services PMI rising sharply to 52.7, a level which indicates services are back to a reasonable growth path; but it was not so good for the manufacturing PMI, back down to a nasty 46.4 and therefore definite contraction.

This dynamic was also the case in Europe until recently, but things seem to have changed and for the worse. The hope was for weak manufacturing to bounce but, unfortunately, service PMIs have shifted downwards to join manufacturing in the doldrums. Perhaps it is little wonder that despite the newly dovish mood music from the Fed, investors continue to see the ECB as the major central bank most likely to cut rates first, with the BoE not far behind.

Beyond the positivity from the service sector, we should also note that the UK is going through a bit of bounce in the housing market, now that 5-year fixed rate mortgages on offer have dropped back to around 4.5%. The housebuilders are up since the start of this last quarter by over 17%, currently beating every other sub-sector. And this is not confined to the UK, it’s interesting to see how house prices are also bouncing in other global regions.

Next year will probably be full of political drama. Hopefully, it will be the agreeable kind, borne out of a smooth democratic process. Major elections will happen here, in the US and many other major nations. Returning to the theme of central banks, it will not just be politicians having their records and behaviours judged. Having endured the almightiest inflation episode, central bankers may have decided to tread more carefully over this coming year, so as not to inflame sensitivities during a period of heightened political debate. This is not to say that they will develop biases, nor that central bankers will be self-serving. Rather, we should expect that their messaging will be less confrontational. Perhaps, if there is to be an impact on policy, it will be that they will prefer to act a little more quickly if inflation (especially wage inflation) allows.

On the back of the Fed’s sentiment change announcement, equity markets have in general had another good week. The exception was once again China. The western world’s elections are part of a system which spreads power and responsibility across many people and institutions, and thereafter holds them accountable for their actions in a transparent way. China has no such system and appears to be going through a crisis of confidence wherein its autocracy is a large part of it. Just over a week ago, Politico reported that Xi Jinping appeared to be purging his erstwhile lieutenants in a Stalin-like manner, confirming rumours we had picked up on the City grapevine. We cannot know the truth, but should hope that China is able to break this current spiral soon, so that confidence and economic sentiment can return to what is after all the second largest single economy.

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