Markets Now Accept Rate Cuts Unlikely

  • Inflation has proven sticky, even as growth weakens. Markets are realizing that policy rates are set to stay higher for longer. We like quality in stocks and bonds.
  • Tech stocks surged further last week even as debt ceiling talks spurred bouts of volatility. Long-term bond yields climbed on still-hot U.S. inflation in April.
  • U.S. jobs data this week should show a tight labor market is keeping wage pressures elevated. We think that keeps inflation sticky and above policy targets.

Since the end of 2022, we’ve been saying that rate cuts this year would be unlikely as inflation sticks around. Markets are waking up to our view as a look under the hood reveals signs of weaker growth in major economies and market weakness due to rate hikes. Debt ceiling talks and the U.S. Treasury potentially being unable to pay its bills by early June have added to recent market volatility. We like quality in portfolios. We upgrade UK gilts to neutral as yields price in more rate hikes.

A big divergence

Stubbornly high inflation has prompted the Fed’s fastest rate hike campaign since the 1980s. Markets are no longer pricing in repeated Fed rate cuts, a sign they’re grasping inflation’s persistence, in our view. And the full effect of central banks’ rate hikes is kicking in. Data last week showed Germany has entered recession even with a smaller-than-feared energy shock. In the U.S., GDP has held up but it has arguably entered a recession based on gross domestic income, which assesses the economy’s performance on an income rather than spending basis. A deeper look reveals stocks reflect worsening growth: The S&P 500 index was up nearly 10% so far this year (dark orange line in the chart). But a few large technology firms valued above $200 billion are driving those gains as they benefit from the artificial intelligence buzz. Applying equal weighting to all companies in the index regardless of size shows it’s down over 1% this year (yellow line) – extending 2022’s hefty losses.