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Keeping a stiff upper lip

Market Update

06.05.2024

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What happened last week?

US

  • The Federal Reserve (the Fed) held interest rates steady for a sixth time.
  • Strong corporate earnings were mostly met with a shrug.


Asia

  • The yen perked up, possibly because of a currency move from the Bank of Japan.


Europe

  • The European economy saw better-than-expected growth, easing worries about a recession

What does this mean?

The Fed dropped a reality check last week: no interest rate hike now and no rate cuts anytime soon either. The economy’s still too sizzling for that, and anyway, the Fed’s mission to flatten inflation isn’t yet accomplished. While a booming economy sounds great, keeping rates up has its challenges: it makes life a lot more expensive for borrowers, affects the value of future earnings for businesses, and raises the odds of a recession or some serious market mishaps further down the line.

Earnings from companies like Meta and Netflix have been coming in hot, but stocks have been a tad frosty and the recent reality check on interest rates probably has something to do with that. Higher interest rates should push stock valuation down, after all, because they make safer investments like bonds a lot more attractive. But it could also be that investors – spoiled by a long run of past wins – now have unrealistic expectations and are willing to hit the “sell” button at the tiniest hint of a stumble. What seems clear is that there’s been a shift in focus: instead of just riding a wave of AI hype, investors are scrutinising the returns on those investments. And that could leave stocks walking a fine line.

The weak yen has boosted Japanese stocks, attracting foreign investors and increasing the value of overseas earnings. But the currency could be dropping too far, too fast – and that could rattle investor confidence, hurt import-reliant businesses, and even dampen consumer spending. It’s no wonder, then, that when the yen jumped higher twice last week, everyone pointed the finger at the BoJ, suspecting it of selling foreign currencies and buying up its own, to help prop up its value. The more important question though, is whether that’ll work.

The market sentiment was a whole lot better across the EU last week, as economic data showed a surprisingly strong 0.3% growth spurt. The news helped ease recession worries, with Germany, France, Italy, and Spain all outpacing expectations. The European Central Bank (ECB) joined in on the optimism too, forecasting that economic expansion will accelerate to 0.6% this year and 1.5% next year. Meanwhile, inflation held steady in April across the bloc at 2.4%. It wasn’t the tick downward that many had hoped for, but it could still leave the door open for an ECB rate cut in June.

This week’s focus: Keeping a stiff upper lip

This is a tense moment for the UK, as it grapples with one of the most bitter growth-and-inflation mixes in the G7 club of advanced economies. Though, consumer price rises in Britain have eased from 11% to 3.2%, the figures are still higher than anyone would like. The growth picture isn’t more cheerful: the OECD is forecasting that economic expansion will hover around just 0.4% this year, worse than most of its G7 peers, except Germany. That’s got the Bank of England (BoE) caught in a bind: it wants to cut rates to boost growth but it knows that doing so could undo the progress it’s made in cooling inflation. With inflation not going down so easily, the thinking in markets is that those interest rate cuts will have to wait a few months longer.

If Britain’s feeling down about its inflation and growth troubles, you wouldn’t know it to look at its stocks. The blue-chip, internationally exposed FTSE 100 has been flying high, fuelled by gains in “old economy” sectors like energy and materials as investors acclimate to the idea of higher-for-longer inflation and interest rates. It looks like the FTSE 250 – home to zippier, domestic-focused firms – could fly even higher. Its valuations are lower than its bigger buddies, so it’s got more room to bounce if the BoE announces a market-pleasing interest rate cut or if the economy outperforms all those grim projections.

But remember, the UK isn’t in a bubble. Over in the US, folks are gearing up for some hefty Treasury auctions this week, tossing 10-year and 30-year bonds into the ring. It’s more than just a sale; it’s a status check on how hot (or not) US debt is. A poor showing could shake up US interest rates and sour the market mood and that could spell trouble for the UK too, as higher US yields could force the BoE to delay Britain’s interest rate cuts. After all, higher US rates would weaken pound sterling (as investors chase better returns in America), making imports pricier and nudging UK inflation upward again.

The Week Ahead

  • Monday: UK holiday, eurozone PMI (April). Earnings: Palantir, Microchip Technology.
  • Tuesday: Reserve Bank of Australia interest rate decision, eurozone retail sales (March). Earnings: Walt Disney, BP, UBS, Electronic Arts, Rivian, Reddit, Lyft.
  • Wednesday: US 10-year Treasury auction. Earnings: Uber, Arm, Airbnb, Shopify, Robinhood, Toyota, Duolingo, Hubspot.
  • Thursday: Bank of England interest rate decision, US 30-year Treasury auction, China trade balance (April). Earnings: Petrobras, Brookfield.
  • Friday: UK economic growth (Q1), China inflation (April), US consumer sentiment (May).

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