Weekly market update – Has inflation finally been beaten?

Yields dropped significantly last week, and stocks resumed their rally towards all-time highs, as markets are now pricing in rate cuts in early to mid-next year. 

With the conflict in the Middle East contained within the region and no mention of oil embargoes, the question on everyone’s mind is whether this second wave of inflation has been finally pushed back. Are we inching towards normality? 

Our opinion is not too dissimilar from that of central banks. “Wait for it”.

For one, we are now entering the festive season, when discretionary spending finally picks up. Consumers have learned to wait for sales on Black Friday. Following that, there’s traditional Christmas spending. We should therefore wait for December’s data for a more accurate picture. 

Second, in terms of non-discretionary spending, energy prices might be coming down, but tensions are still high. The recent energy and food conflagrations as a result of war weren’t accidents. They were engineered. It stands to reason that leaders who want to see further political upsets won’t necessarily stop here. 

Third, there’s no real estate crash. While this is good for those who own the asset, it’s bad for those who need it and have to pay for it as it keeps rents high. City-based workers are still forced to demand higher salaries at year-end, which employers might have to pay. 

Fourth, labour markets remain rather tight across the board. This means that getting back to a sustainable 2% inflation path will not be easy. Many Fed members have expressed the opinion that they might have to do more inflation fighting, and it would be unwise not to take them at their word.

Long-term factors are not very positive for inflation returning to a sustainable 2% either.

Infrastructure spending still needs to happen en masse. We are moving from the era of computing to the era of AI. At the same time, we are moving from the era of the Pax Americana to a multi-polar world, which requires supply chains to be rebuilt. Infrastructure has been suffering from underinvestment in the Western world for years. The US has picked up the pace, but Europe is still falling behind.

And then there’s the issue of debt. Global debt to GDP stands at a near record of 340%. Interest payments in the US and the UK are soaring. Government fiscal expansion does not help the fight against inflation. And if governments want money to keep refinancing their debt then they will either need to pay a decent yield to investors or test central bank independence by compelling them to buy government debt.

Inflation might be down, but it is probably not out. Central bankers are right to worry about declaring victory too soon. They have been burned in the past. To quote Winston Churchill, “we must be very careful not to assign to this deliverance the attributes of a victory”. At least not just yet.

Where we stand today, we need to see more compelling evidence of consumer weakness, as well as government restraint against pro-cyclical fiscal expansion.

What does this mean for investors?

One, a bet on rates coming down might be premature. Markets are now betting on May for the first US rate cuts, but markets also have a history of mispricing rates. Yields coming off too fast actually undermines the rate pause, which was partly justified by the fact that the market had done a lot of tightening for central banks. 

Second, there’s no need to rush locking in a yield. Yields aren’t going to disappear. A decade and a half of zero-rates was traumatic for buy-and-hold bond investors, to be sure, but with all the debt and the spending that needs to happen, we aren’t likely to experience floored interest rates and below 2% inflation anytime soon.

George Lagarias, Chief Economist

Market update

Stocks and bonds performed strongly last week as US and UK inflation came in below consensus estimates. Developed markets outperformed emerging markets in Sterling terms, with European equities leading the way with a +3.5% return. UK equities also performed well, gaining +2.1%, while US equities lagged behind with a +0.5% return. Japanese equities were slightly positive, returning +0.7%. Emerging market equities returned +1.0%. Returns across regions were generally stronger in local currency terms as Sterling appreciated by +1.8% versus the US Dollar. Bond yields saw declines across the major economies, as traders welcomed lower inflation figures. The US 10-year Treasury yield fell by 17 basis points to 4.44%, while the UK 10-year gilt yield dropped by 22 basis points to 4.18%. The commodity market was mixed, with gold rising by +2.0% and oil falling by -1.7% in US Dollar terms.

Macro news

• Headline inflation in both the US and UK was below expectations for the month of October. The UK’s inflation rate dropped to 4.6% (versus 4.7% expected) from 6.7% in September as energy prices for consumers fell sharply, while the US inflation rate fell for the first time in three months to a rate of 3.2% (versus 3.3% expected). On a month-on-month basis, price levels were unchanged in both the UK and US.
• UK retail sales fell by 0.3% in October, against economist expectations for a 0.3% rise. The data for September was also revised down to a fall of 1.1%. The fall in October was attributed to a drop in automotive fuel sales volumes due to rising prices in recent months. The volume of retail sales in October fell by 2.7% to its lowest level since February 2021, indicating that consumers are buying fewer goods but at higher prices.

The week ahead

Investors will be eager to read the Federal Reserve’s minutes from its most recent meeting, which will be released on Tuesday. On Wednesday, data on durable goods orders will be released for the US, while flash PMIs will be released towards the end of the week for the UK and the US among others.  

Economy and investment webinar

On Wednesday 29 November, join our Chief Economist and Chief Investment Officer as they discuss the current economic landscape, both here in the UK and globally.

Register here