The year-end rally in 2023 was truly impressive, as most market indices around the world gained significantly more than ten percent in value within just a few weeks. The first trading days of the new year were quieter – but things could soon look up again, at least observers of the bond market believe.
• Yields on US government bonds have recently fallen significantly
• Falling inflation rates give investors hope for interest rate cuts
• First Interest rate cut in the USA as early as March?
The international stock markets have partially taken a break after their year-end rally in November and December, during which many major indices such as the DAX, the Dow Jones, the S&P 500 and the NASDAQ 100 set new record highs. The upward pressure has noticeably diminished. Analysts and investors are wondering whether the stock market traders’ optimism was exaggerated given the ongoing economic weakness and possibly premature expectations of interest rate cuts. To answer this question, it might be worth taking a look at the bond market.
Bullish signal? US Treasury bond yields falling
Bond experts see a positive signal that could also give the stock market a boost: the yield on ten-year US government bonds has recently fallen noticeably. On November 23rd of last year it had reached its highest level since 2007 at 5.022 percent, but since then it has declined significantly and fell below the much-noticed four percent mark. The yield on ten-year US Treasuries is now 4.175 percent (as of January 24, 2024). The yield on two-year US government bonds also followed the downward trend: after a multi-year high of 5.289 percent on October 4th, it also fell significantly and is currently at 4.390 percent (as of January 24th, 2024).
How bond yields affect the stock market
Investors pay so much attention to the yield on US government bonds because it acts as a gauge for the trillion-dollar interest rate and bond market. The higher the return that bonds provide, the less attractive stocks become: Investors can earn money with their capital without much risk and are therefore more likely to shy away from the higher risk on the stock markets. In addition, high interest rates also have negative microeconomic effects: households and companies reduce their investment rate because the necessary loans are expensive. The overall demand for goods and services therefore tends to decrease when interest rates are high.
On the other hand, when interest rates fall, company shares tend to become more popular among investors. The increasing demand then leads to higher prices on the stock markets. In fact, this mechanism has been proven with astonishing precision in the recent past: For example, the largest indices such as the Dow Jones, NASDAQ 100, DAX & Co. reached a multi-month or even annual low at exactly the time when US government bonds reached their multi-year high : End of October. When the US central bank Federal Reserve (Fed) signaled that it would begin cutting key interest rates in 2024 in view of the trending weakening inflation pressure, bond yields went downhill – and stocks went up.
Inflation data suggests lower inflation
In addition to the labor market data, the interest rate expectations that are linked to the Fed depend primarily on US inflation rates – and these have recently been falling consistently. Recently, the increase in producer prices in particular has fallen, which in turn has an impact on both the calculations of the Consumer Price Index (CPI) and the US Federal Reserve’s preferred price index for personal consumption expenditures (Personal Consumption Expenditures Price). Index, abbreviated PCE). Prices paid by U.S. factories before goods leave the building fell 0.1 percent in December and rose just 1 percent from the same period last year, indicating a sharp decline in goods prices. The core producer price index, which excludes food and energy costs, rose 0.2 percent in December and 2.5 percent year-on-year. Both of these values were below analysts’ expectations.
The CPI index, however, rose by 0.3 percent for the month and was therefore slightly higher than analysts had previously expected. They had assumed an increase of 0.2 percent. Over the year, price inflation was 3.4 percent; in the previous month it was 3.1 percent. However, Ian Shepherdson from Pantheon Macroeconomics puts the slightly higher CPI index into perspective: “For the Fed, the core PCE value is crucial, and this data will increase the pressure on decision-makers monetary policy to be relaxed soon,” “TheStreet” quotes from Shepherdson’s reaction.
Fed interest rate cuts starting in March?
Where the bond and stock markets go in the short to medium term will depend primarily on when the Fed implements the first key interest rate cuts. Bank of America uses historical data to answer this much-debated question. In her influential Flow Show report, she notes that in the last 90 years only five interest rate cuts – all related to war or recession – were made when core inflation was above 3.9 percent. Inflation is slowly approaching a territory where interest rate increases are becoming more and more realistic. According to the CME Group’s “FedWatch Tool”, 40.5 percent of market participants expect the first interest rate cut to between 5.00 and 5.25 percent in March (currently between 5.25 and 5.5 percent). . This could be registered with relief by shareholders and companies, as it would make company shares more attractive and investments cheaper.
Editorial team finanzen.net