The rally continues amidst falling inflation

• Equity markets continued their November strong run this week. The rally was supported by inflation for the US and UK both falling more than expected (3.2% and 4.6%, respectively). This should provide comfort for the market that the US Federal Reserve (Fed) and Bank of England (BoE) will keep interest rates on hold, which aligns with our view that we’re at peak rates in the West.
  
  
• The market debate will now shift towards when central banks should start cutting rates. In the US, despite pockets of weakness (jobless claims rose and retail sales fell last week), the US economy is still quite resilient. Therefore, we forecast that the Fed – along with the BoE and European Central Bank (ECB) – will start reducing rates around mid-2024 after the slowdown in growth accelerates.
  
  
• This means that the peak in developed market bond yields (which fell last week) is already likely behind us. This is good news for our position in US Treasuries, because as yields fall, prices increase.
  
  
• Elsewhere, emerging market equities outperformed their developed market peers last week, mostly driven by the fall in the US dollar and bond yields. Improving Chinese data (industrial production and retail sales were both up more than expected) was likely an additional contributor.
  
  
• However, house prices in China fell again in October, casting doubts that Beijing’s efforts to revive demand is not feeding through. This lack of clear direction in China amidst a deflationary environment and the broader impact on emerging market economies is why we’re maintaining a neutral stance on both bonds and equities in the region.
  
  
• Lastly, oil prices continued to decline, closing below 80 US dollars per barrel. This suggests that the market is not as tight as initially expected, with the fall in demand offsetting the reduction in production from oil producers.

• Last week’s data confirmed our expectations that inflation will continue to moderate, which also supports our view that Western central banks are done with interest rate increases.
  
  
• In this light, we’re not changing our portfolio positioning. High-quality bonds are attractive as interest rates peak, growth slows and inflation eases. Therefore, we hold more government bonds and less riskier bonds relative to our long-term allocation.
  
  
• In equities, we still hold slightly fewer equities relative to our long-term allocation, focusing on large, high-quality companies across the US and Europe, which are less volatile than the broader market. This equity selection has performed well during the recent rally.

• The Purchasing Managers’ Indices (PMIs) for November are out this week, in the Eurozone and the UK on Thursday, and the US on Friday. The market expects that manufacturing and services output will continue to contract in the Eurozone and the UK. This means that these two economies are likely to fall into a mild recession.
  
  
• In other data, this Friday’s German ifo business climate, an important gauge of activity for the largest Eurozone economy, is expected to show extra signs some stabilisation, but at low levels. In Sweden, there’s a market debate on whether the central bank will deliver a final interest rate increase, expected by a minority of forecasters, or keep rates unchanged at 4%.
  
  
• The Organization of the Petroleum Exporting Countries (OPEC) meets on Sunday and the outcome of the meeting could lead to some volatility in the oil market. The recent weakness in oil prices may cause the cartel members to continue their production cuts into the start of 2024.

Past performance is not a reliable indicator of future returns.