Recent bond yield declines and cautious central bank approaches have buoyed short-term stock market sentiment. However, our analysis reveals forthcoming challenges for equities.
The Federal Reserve’s prolonged high interest rate stance, lofty valuations, overly optimistic earnings projections, weakening pricing power, and ongoing revenue growth deceleration pose risks. Discerning between a healthy slowdown and early recession signs remains complex, underscoring the narrow ‘bad news is good news’ zone.
As we anticipate the conclusion of the current economic expansion within 12-18 months, there’s optimism surrounding a softer landing scenario this year. The Federal Open Market Committee (FOMC) maintained its position last week, despite robust Q3 GDP growth and persistent inflation. While rising bond yields influenced this decision, Chair Powell cited “significant progress” in quelling inflation, primarily attributed to improved supply-side performance. Consequently, the potential for an additional Fed rate hike has diminished, even though Q4 2023 core inflation is expected to rise. Softening labour market data in the US, Euro area, and Canada, coupled with disappointing global business surveys, have prompted rates markets to factor in an increased risk of a sharp economic slowdown.
Euro area core inflation is predicted to fall below 3%, while stability prevails elsewhere. October’s Euro area inflation data fell short of expectations, with core inflation currently running at a 3% annual rate after adjusting for distortions. As wage growth is expected to align with prices, a further drop in Euro area core inflation during 1H 2024 should keep the European Central Bank (ECB) in a holding pattern. Recent inflation disappointments also indicate that the Norges Bank is likely to maintain unchanged rates in December. However, the Bank of England’s (BoE) stance remains uncertain. We anticipate the BoE’s status quo throughout 2024 but acknowledge that it may be compelled to raise rates if early 2024 witnesses a recovery alongside sustained high inflation.
In the US, recent developments have opened a window for a weaker US dollar. Still, it’s essential for those betting against the dollar to consider the durability of this trend. US exceptionalism persists, contrasting with a less stable global economic environment compared to a year ago. Although US yields could exert downward pressure on the US dollar, markets have already priced in Federal Reserve interest rate cuts in the first half of the year, while concerns regarding Treasury supply persist as a notable theme.
Geopolitical risk premiums may linger in the European natural gas sector, primarily influenced by weather-related factors. As of October 29th, Northwestern Europe’s natural gas storage is nearly at full capacity, yet the TTF natural gas price remains around 50 EUR/MWh. This pricing indicates concerns about potential supply interruptions resulting from the escalating Israeli conflict. Weather conditions have been milder than anticipated this winter season, but uncertainties about peak weather-related demand from December to February sustain the current risk premium in flat natural gas prices.
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