Financial Update from Brewin Dolphin - 15 March 2024

March 2024

The Weekly Round-up

Friday 15 March 2024

In his latest weekly round-up, Guy Foster, Chief Strategist, discusses inflation figures and interest rate cuts, China’s stock market rally, and positive UK GDP estimations.

Hopes for seemingly enormous interest rate cuts during 2024 have been dissipating since the year began. Two months ago, investors thought interest rates would finish the year at just over 3.5%. Now that is just over 4.5%, implying there may be three interest rate cuts.

But why the change in mood?

In short, inflation has remained stickier than expected. This week’s consumer price index (CPI) print saw core inflation slightly above estimates for the second month in a row. Recent monthly readings have been consistent with a rate of core inflation of 4%, which is clearly too high.

Core CPI excludes the volatile food and energy prices that can make interpreting the data difficult. After this adjustment, shelter inflation makes up 45% of what is left. Some of the shelter data is very lagged in its impact because it relates to when tenancy agreements are renewed. Therefore, the Federal Reserve has discussed core services excluding shelter (so called super-core inflation) as a preferred measure. That rate also remains well above the Federal Reserve’s target rate.

On Thursday, producer price indices, which measure the prices of goods sold by their manufacturers, were also above estimates. This seems to fit the phenomenon that we have been highlighting over the last few months, that more companies are experiencing high services output prices.

A matter of ‘when’ rather than ‘if’?

All this sounds pretty concerning given the narrative for 2024 has been about interest rate cuts, and markets have certainly paused for breath. So far, though, investors still believe the question is ‘when’ rather than ‘if’ rates will be cut. Despite a full percentage point of cuts for this year being erased, long-term bond yields have risen by around 0.2%.

Theoretically, if you believe that companies are valued based upon bond yields with an acceptable equity risk premium, the stock exchange would be quite responsive to small changes in bond yields, but the evidence to support this is lacking.

Instead, the interaction between share prices and interest rates seems more likely to reflect the broader concept of liquidity, which so far this year remains reasonably abundant. The notable risk on this front would be if liquidity support for U.S. regional banks was to diminish, as we are now a year past the crisis.

U.S. retail sales accelerate in January

U.S. retail sales expanded at the fastest pace in five months during January, which could have given policy makers more inflationary fears to fret over. But this rebound reflected an improvement in the weather rather than a resurgence in animal spirits. Inclement weather caused a sharp decline in shopping trips during January and most of the recovery in February was driven by building materials and garden equipment, both of which are weather sensitive. U.S. goods demand therefore remains in the doldrums, with services having been the category of choice for consumers.

Chinese stocks bolstered by new growth target

Chinese stocks had a good week overall but were struggling for momentum by the end of it. The enthusiasm for these stocks has been bolstered by the idea that the newly announced growth target implies powerful stimulus must be coming.

Alas, it remains a trickle rather than a gush.

Despite property prices, which we learnt today are continuing to decline, and bank loan growth, which decelerated to its slowest pace on record last month, the authorities have not been forthcoming with stimulus. Instead, China drained liquidity from the banking system during February and held interest rates steady.

The Chinese economy has shown some green shoots of recovery, with prices at last rising again in February after four months of deflation. It seems likely more stimulus through lower reserve requirement ratios and lower interest rates will eventually be unleashed.

UK GDP estimate turns positive in January

Green shoots are also evident in the UK. The January estimate of monthly gross domestic product (GDP) turned positive, which was implied by the already-released retail sales numbers for that month.

The recovery in the housing market continued as well, as this week’s Royal Institution of Chartered Surveyors (RICS) house price index would seem broadly consistent with house price growth of up to 5%. Demand for housing has recovered following a normalisation in borrowing costs. Most encouraging is that new sellers are entering the market as well, suggesting the recent uptick in prices is perceived to last. And it’s not just the secondary market for homes that is recovering.

More housing market activity also seems to be drawing a line under the fifteen-month housebuilding recession that the UK has suffered. More housing transactions are good for economic activity as they are labour intensive to build and even selling already existing homes triggers a chain of connected economic activity from financing to furnishing.

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