Spring is around the corner, and it seems the time is nearing when the markets hope interest rates will start coming down. What should investors keep in mind as we head further into spring and summer?
The start to the year in different markets has turned out to be somewhat different than was expected at the turn of the year. This market review sheds light on the year-to-date situation on the markets and the themes that are worth keeping an eye on as spring progresses.
Early in the year, the markets still priced in several interest rate cuts for the current year. However, the year has got off to a relatively slow start, and no interest rates cuts by central banks have been seen yet.
One explanation for this might be the US inflation, which has behaved differently from what was expected at the start of the year. In the USA, both headline inflation and core inflation, i.e. inflation less food and energy, have not fallen over the past six months as expected.
US inflation is still around 3–4 per cent, which is above the central bank’s two per cent inflation target. Whereas the markets priced in up to six interest rate cuts for this year in the USA, this figure has in the meantime dropped to just around three.
This means that inflationary pressure in the USA continues to be high, and the country’s strong labour market report published last week did nothing to ease it. The Fed thus still faces relatively little pressure to start lowering interest rates, although the central bank has nevertheless maintained its stance that it will start the interest rate cuts this year.
The situation is somewhat different in Europe, where inflation has slowed more than in the USA. In Europe, despite recent positive signs, economic growth is trending down.
In this context, the ECB is believed to start its interest rate cuts before the Fed. At the moment, it seems likely that the ECB will start its interest cuts in the summer. However, it cannot be ruled out that the central bank will announce the start of interest rate cuts at its interest rate meeting on Thursday this week.
Interest rate cut expectations have also been revised down for the ECB, although, due to slowing inflation, the pressure to lower interest rates is more urgent in the euro zone than in the USA.
The growth outlook in the USA has remained strong in the early months of the year. Last year, the USA was still expected to slide into a downturn, but these expectations have now been swept away. Rather than a downturn, a soft landing or a horizontal flight are considered to be more likely scenarios.
While the USA used to clearly stand out in a positive way from other market areas, economic data from Europe and China is also improving and the differences between markets are levelling off. However, the burden of global growth expectations still largely lies on the USA’s shoulders.
The higher interest rate level has impeded the growth of the most interest rate-sensitive economies, but its impact on global growth remains low. The differences are already discernible, though, with Canada, which is more sensitive to interest rates than the USA, publishing a much weaker labour market report last week.
Strong market sentiment has continued year to date, with global equity markets rising and credit spreads tightening as a result of growing risk appetite.
In the equity markets, the USA has clearly been the strongest area. The development of the European equity market as a whole is weighed down by the weak performance of the UK, for example, but when only considering the euro zone, it has fared almost as well as the USA. Emerging markets dipped early this year due to the challenges faced by China, but from February onward, the market has been catching up with Europe. In Finland, the situation continues to be weak, and no relief seems to be in sight in the foreseeable future.
The top in the equity markets has somewhat levelled off compared to last year, and reasonably strong growth has been seen also outside technology companies. However, there is still not much room at the top, and the five largest companies in the US equity market currently represent more than 25 per cent of the market.
Optimistic economic and inflation expectations have increased market expectations of strong earnings growth, keeping global equity valuations at a high level. In the fixed income markets, return expectations have moderated slightly, but many still see fixed income investments as attractive in relation to risk.
Nothing presented here is or should be taken as an investment recommendation or solicitation to subscribe for, buy or sell securities. When making investment decisions, the investor must carefully familiarise themselves with the information given on the financial instruments and understand the related risks. The investor must base their decision on their own assessment, goals and financial situation. Risk is always inherent in investment activities. The value of the investment instruments may increase or decrease. The past performance of investment instruments is no guarantee of future performance.
