What’s going on in financial markets? Which macro themes should you watch? Drawing on our depth and breadth of market and economic expertise, Market Pulse brings you insights on the latest investment themes to help preserve and grow your wealth. 

Market views

• The Federal Reserve’s interest rate decision (see details in next section) was the main driving factor in markets last week. Although it held rates steady, Federal Chairperson Jerome Powell’s commentary around the decision unnerved markets. The first suggestion from Powell’s comments was that interest rates could go higher in the future. This is not surprising, if inflation data does not continue to soften, then central banks will be obliged to raise rates further. The second implication from Powell was that interest rates will stay higher for longer, which has been a debating point for some time. At Goodbody, we are believers in the ‘higher for longer’ narrative, so we are not perturbed.
• Fixed income markets were down but there were some interesting talking points. Firstly, the losses were not large, the return from the euro area bond market was -0.4%, higher running yields are limiting losses. Secondly, the euro area is out-performing others, the US fixed income market returned -0.5% last week. Thirdly, the yields curve flattened somewhat. In the euro area, 1-Year yields were up 2bp, less than the running yield. A key point for current markets: keep a preference for the euro area fixed income market and select short-dated over long maturity.
• Equity markets had a more difficult week, down 2.6% in euro terms. All major regions were down, as well as all sectors. Defensives (Healthcare; Consumer Staples and Utilities) held up better but were still down. Equity markets must contend with higher bond yields depressing all sectors and the impact of ‘higher for longer’ on future economic growth. We think bond yields are close to their peak and thus valuation pressure should subside, but we would be nervous about the future growth rate. Hence our defensive positioning within equity markets.

Macro views

• Central banks are centre stage again this week. The main one was the Federal Reserve in the US with its policy setting committee (FOMC) meeting, which left policy rates unchanged but did leave the potential for further rate rises in the future. It also updated its projections for the US economy (last done in June), increasing the expected growth rate, reducing the unemployment rate and slightly reducing the projected core inflation rate. The ‘dot plot’ (the median committee member’s projection for interest rates) still calls for one more hike this year. What caught more attention was that it was only 50bps of cuts compared to 100bps in June. The ‘higher for longer’ narrative is holding strong.
• The Bank of England also had its policy meeting last week and decided to leave interest rates unchanged. It seems to have been a finely balanced decision and interesting to see it concentrate more on forward looking indicators (economic growth and economic slack), and less on backward looking indicators (inflation and wage settlements). It also appears to want to tackle inflation by holding rates at the current high levels for longer, rather than increasing them any further. We are close to/at the peak but the drive is still ‘higher for longer’.
• There was some good and bad news from the euro area last week. The main business surveys (Purchasing Managers Index) were released and showed that the composite index was up month-on-month but remains in contraction territory. The recovery is coming from the services industry, the manufacturing sector was down again month-on-month. The details were mixed: the new-orders index, the best lead indicator, was down but the employment index was up. Overall, it’s good to see the deterioration halted but we need better numbers more consistently.

Chart of the week: Are we there yet?

The chart above shows how markets are pricing Federal Funds (policy interest rate in the US) in twelve months time. When we had the bank insolvencies in early March this year, markets began to price in aggressive cuts to interest rates over the following 12 months. We viewed this as too optimistic, and we felt uneasy about what could happen if expectations became more accurate. Fast forward to today, and that is where we are. The implied policy rate is now in-line with the ‘dot plot’ from the Federal Reserve. Expectations have become realistic and that is why we are now more optimistic about fixed income markets.

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