No January blues for the markets

The January blues passed markets by with the S&P 500 up 8% since the turn of the year as inflationary data continued to point to a peak being reached. The US Federal Reserve, Bank of England (BoE) and European Central Bank (ECB) made their first policy announcements of 2023, thereby setting the stage for the path of future rate hikes this year. As ever, the rate increases were widely expected by financial markets and so it was the subsequent press briefings that garnered the most attention.

What is happening in the US?

The Federal Reserve increased its benchmark interest rate by a quarter of a percentage point on Wednesday – its smallest increase in a year – taking the federal funds rate to a range of 4.5% to 4.75%. The start of February marked a return to a slower and more orthodox pace of rate rises. The shift reflects the fact that data is increasingly suggesting inflation may have peaked, a view supported by the slowing increase in employment costs during the final quarter of 2022.

Fed chair Jerome Powell acknowledged there were some encouraging signs that price pressures were easing, but said it was “very premature to declare victory” and that policymakers would need “substantially more evidence to be confident that inflation is on a sustained downward path”. He also acknowledged it would take time for the full effect of rate rises to feed through to the economy, but indicated that Fed officials are more concerned about doing too little to lower inflation than squeezing the economy too much.

US jobs data provided positive signals on growth, inflation, and the trade-off between the two. But from an equity investors standpoint, the news wasn't all good. The main concern was that the unemployment rate dropped to a new cycle low of 3.4%. The last time the unemployment rate was lower than this was in the early 1950s. The Fed funds rate tends to move inversely with the unemployment rate. With the unemployment rate hitting a new low, the implication is that it's very likely that the Fed has not finished hiking rates. Unsurprisingly, US Treasury bonds sold off on January’s payroll report and the dollar rallied. Stocks also sold off, providing evidence that we are in a “good news means bad news” environment. But the equity market sell-off was relatively muted, partly because the details of the report were so positive.

What is happening in the UK?

Here in the UK, the BoE’s monetary policy committee (MPC) voted to increase the base interest rate by half a percentage point to 4.0%, a 14-year high. Encouragingly, the MPC said further rate hikes would only be needed if there were new signs that inflation was going to stay too high for too long. This was interpreted to mean that interest rates might peak at the current rate of 4.0%, with no further rate hikes this cycle, (markets had been pricing in a peak of 4.5%). This stems from the fact that inflation is expected to ease from 10.5% in December 2022 to under 4% by the end of this year and then drop below the BoE’s 2% target in 2024. Nevertheless, the bank said the hike on the 2 February 2023 was needed because “the risks to inflation are skewed significantly to the upside”.

What is happening in Europe?

The ECB took a more hawkish tone after announcing a half a percentage point increase in interest rates on 2 February 2023. The increase takes the ECB’s benchmark deposit rate to 2.5%, the highest since the global financial crisis. Whereas the Federal Reserve slowed the pace of tightening and the BoE signalled rates may have peaked, the ECB repeated its intention to “stay the course”, which has become its mantra in recent weeks. ECB President, Christine Lagarde’s more hawkish press conference can be partly explained by the fact that the ECB began lifting rates later than the Fed and BoE, and it started from a much lower base with interest rates in negative territory until July 2022. 

What have we witnessed so far with the earnings season?

Aside from interest rate hikes, we are now halfway through earnings season and the tone is pretty well set. After exceeding estimates with revenue of $32.16billion in the fourth quarter, Facebook owner Meta indicated that year-over-year sales in the first quarter of 2023 could rise, thereby ending its streak of year-over-year declines. In contrast, the other major tech giants disappointed. Apple posted its first quarterly revenue decline in seven years after COVID-19 and protests in China disrupted production. Amazon and Alphabet missed expectations, with the latter pointing to lower demand for search advertising. Outside of the tech space, oil and gas giant Shell hit the headlines with record annual profits of £32.2billion – double last year’s total – after energy prices surged following Russia’s invasion of Ukraine. US counterpart, ExxonMobil, enjoyed even greater profits raking in £45.2billion in 2022 – a remarkable change of fortunes for oil majors which had slumped during the pandemic when plummeting demand caused oil prices to actually turn negative in April 2020.

Looking ahead

So, markets have started the year positively despite some earnings disappointments and mixed economic data. A sign, perhaps, of over optimism from investors keen to put 2022 behind them? With plenty of uncertainty around potential recessions in the UK and US, volatility is likely to persist. There is still much to be done before the global economy can be said to have shrugged off the lingering aftereffects of the pandemic, and the uncertainty brought about by the tragedy which continues to befall Ukraine. 

Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at Brewin Dolphin)