Interest rate cuts under review

In recent months, market participants have been gaining confidence in upcoming interest rate cuts. However, macroeconomic data forces central banks to maintain a continued stance of restrictive monetary policy.

It has been nearly two years since the Federal Reserve adopted a restrictive monetary policy course due to a significant rise in inflation. The era of zero interest rates ended. Over the past 24 months, interest rates have been increased at a historically unprecedented pace and lifted to a target range of 5.25% to 5.50%. While the battle against inflation has been a challenging one, it has been successful so far thanks to the drastic measures taken.

With growing confidence that inflation is receding, market participants have begun to anticipate the timing of a shift in monetary policy. Investors are confident that easing will start soon and are looking for lower interest rates going forward. In our outlook for 2024, we have already pointed out that the market expects significantly more interest rate cuts this year than central banks have been communicating. Accordingly, recently released positive economic data out of the US served as a reality check regarding the future course of monetary policy.

Despite carrying the burden of high interest rates for some time now, the US economy continues to show resilience. In addition to a robust labor market and a surprisingly stable residential property market, both the manufacturing and services sectors have seen positive developments in purchasing manager sentiment. In addition, consumer prices rose much more than expected in January, while core inflation also exceeded forecasts. Given this set of data, interest rate cuts by the central banks appear unlikely in the near future. As a result, significant shifts have occurred in the bond market since the beginning of the year. At the start of 2024, the market expected both the Fed and the ECB to cut interest rates six times totaling 1.5%. Initially, the first rate cut was anticipated for March. However, strong economic reality has pushed back these expectations to June, with only four interest rate cuts left for the current year. Concerns about continuous inflationary growth persist, and Chairman Powell emphasized that he would like to see more signs of sustainably lower inflation before considering rate cuts.

Thus, expectations of rate cuts have been put under review, leading to a jump in interest rates for both the Euro and the US Dollar across all maturities. For fixed-income investments, this led to losses since the beginning of 2024. However, the last quarter of 2023 clearly showed how quickly the window of opportunity to lock in higher interest rates can close. Therefore, we consider the current interest rate levels, especially for USD denominated investments, as attractive and recommend investors to opt for longer maturities.

The stock market experienced an incredibly positive start to 2024, with a similar dynamic as in the prevailing year. Once again, the 'magnificent seven,' whose performance was driven by very solid corporate results, were the main driver of equity returns. Upcoming developments around artificial intelligence remain one of the reasons for the robust performance of technology stocks, which propelled the global market to a new all-time high in February.

However, the fact that the market is being dominated by just a few stocks while trading near record levels has historically been a sign of some complacency to macroeconomic data. The S&P 500 is trading more than 1.5 standard deviations above the long-term average forward price-earnings ratio, indicating that many of the expected positive developments are already priced in.