It’s been a strong start to the year for financial assets and in our latest market update this is what we’ll be exploring. Markets have rallied in the first weeks of the year. We think there are a few reasons behind this.
First, we’ve got slowing inflation – at least in the US and Eurozone. It’s worth highlighting that energy prices have declined recently – due to a combination of warmer weather and better supply of natural gas. A few months ago, there were fears of energy rationing this winter. Happily, so far we haven’t seen that.
Second, we’ve got China’s re-opening, an important support for global growth.
Third, we see decent macro data in Developed Markets, suggesting that those economies are doing relatively well so far in the face of higher interest rates.
Finally, in general, we’re seeing corporate earnings holding up okay, even if expectations have come down a bit.
Perhaps Central Banks will be able to bring down inflation without pushing economies into a deep recession. In my view that would be a positive outcome.
Inflation still a concern
So, what are the things that we’re worrying about? Again, there are a few things to consider.
First, we’re seeing inflation come down, and that’s good news, but it’s still well above Central Bank targets.
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One fear would be that inflation slows to a level above the 2% target Central Banks have traditionally used, and then remains quite sticky. This is possible as we’re still seeing the labour market in the US and the UK looking robust, with wage growth well above that 2% target. That might mean Central Banks choose to keep interest rates higher for longer.
A real slowdown still to come?
Our second concern is that we might be opening the champagne a little too soon. The impact of higher interest rates doesn’t affect the public immediately. It takes time for people to really feel their impact.
The resilience we see today in some economies might just mean that the real slowdown is just around the corner. That would have implications for growth and corporate profitability.
The impact of the Russia/Ukraine war lingers
Finally, we shouldn’t forget geopolitics. There’s still a war going on, even if energy markets have adapted better than we might have feared a few months ago.
So, where does this get us? The short-term outlook remains uncertain for economies and financial markets, but the combination of resilient demand and slowing inflation is a good starting point for financial assets as we head into 2023.