Markets hit turbulence amid rate-cut doubts

SINGAPORE – What was supposed to be a continuation of the nine-week rally which had lifted markets to their highest levels in recent years sputtered over the past week amid doubts about the speed at which the

US Federal Reserve might cut interest rates.

Meanwhile, a tick-up of longer-dated US Treasuries prompted a move away from growth stocks, namely tech sector plays.

On Wall Street, the Dow Jones had a turbulent week that saw it lose its grip on a new record as it slipped 0.59 per cent to close at 37,466.11 points. Meanwhile, the broader S&P 500 index fell 1.52 per cent for the week to 4,697.24 points.

The tech-heavy Nasdaq stumbled 3.25 per cent to 14,524.07 points, though it still retains an 8.14 per cent gain since early October.

As expected, Wall Street’s weakness impacted Asian markets.

In Singapore, the Straits Times Index ended down 1.7 per cent for the week at 3,184.3 points. But this was still better than the performance of Hong Kong’s Hang Seng Index, which tripped 2.1 per cent, and Tokyo’s Nikkei 225, which lost 2.4 per cent.

This came as the closely watched 10-year US Treasury yields initially jumped back to above 4 per cent after the latest US jobs report, but subsequently pulled back below 4 per cent as swap traders continued to hold the view that a March rate cut will still take place despite the strong employment report.

The strong jobs report on Jan 5 showed that the US economy added more jobs than anticipated in December, while the unemployment rate stayed steady at 3.7 per cent. From the Fed’s point of view, a tight labour market potentially portends inflationary pressures.

But the biggest danger to receding inflation comes from the geopolitical front.

Threats from Houthi rebels in Yemen to global shipping through the Red Sea have sent freight rates soaring over the past week, and threaten to impact supply chains. The price of oil rose almost 4 per cent last week, though it remains far below its 2023 peaks.

“Global investors need to take seriously the volatility in oil prices due to their direct influence on inflation, as rising oil prices can lead to increased production costs across various industries, affecting corporate profitability and economic growth,” said Mr Nigel Green, who heads independent financial advisory deVere Group. 

“Additionally, oil price fluctuations can create market volatility, influencing the performance of energy-related stocks and sectors, making it crucial for investors to monitor and perhaps adjust their portfolios in response to these changes.”

Also playing on investors’ minds is the upcoming US earnings season. Questions being pondered include to what extent the lagged impact of the highest interest rates in 22 years will have affected corporate bottom lines. Which segments are most likely to be worst impacted? How long will the recovery from bruised earnings take? Who will recover the fastest?

It appears that 2024 is shaping up to be another year with plenty of action for markets.

There is an old investment adage which says that “as goes January, so goes the year”. In short, what happens in financial markets in the first few weeks of the calendar year tends to set the tone for the rest of the year. If this is true, a rocky January could signal a bumpy 2024 for markets.

That said, the current macro environment remains sanguine for equity markets in the medium term and there are good reasons to be cautiously optimistic about the outlook for 2024.

Global economic growth is still positive, the US is unlikely to go into a major recession, and falling interest rates could see a return of cash into equity and bond markets.

But the biggest risk for investors, at least in the short term, is that the market may have got ahead of itself in projecting deep rate cuts by the Fed and other major central banks in 2024. Markets are pricing in Fed fund rate cuts starting in March and projecting rate reductions totalling 150 basis points in 2024.

But minutes from the December Federal Reserve Open Market Committee meeting indicate uncertainty about the path ahead for interest rates, even as policymakers believe rate cuts are likely.

In the minutes, Fed officials noted the importance of a “careful and data-dependent approach to making monetary policy decisions” and stated that restrictive policy would continue to be appropriate “for some time” until inflation sustainably falls to the central bank’s target range. In short, there is a risk that the US central bank won’t move as quickly as markets are hoping for on rate cuts.

Markets may have to recalibrate expectations on rates, and this recalibration could translate to greater market volatility in the coming weeks, said Mr Vasu Menon, managing director for investment strategy at OCBC Bank.

“There is also a tail risk that if the Fed holds off a rate cut for too long, the economy may see a sharper downturn than the soft-landing scenario being priced into markets currently,” he said.

“Much hinges on whether the Fed can engineer a soft landing and investors are not totally convinced that the US central bank can achieve this outcome. Intermittent bouts of uncertainty about this could spook markets and cause volatility in the coming weeks and months.”

But this could also be a year when savvy investors could make handsome gains.

As Maybank Securities’ head of research Thilan Wickramasinghe noted, on a price-earnings basis, the STI is now trading at a 50 per cent discount to the S&P 500.

“This is the lowest level in history, even when taking the global financial crisis (2008) and Covid-19 (2020) into account,” he noted in a report last week. “With the US Fed seen pivoting to a dovish stance following its Dec 23 meeting and with the dot plots pointing to interest rate cuts in 2024, we think this gap is not sustainable going forward.”

Maybank also noted that nearly 40 listed companies here have net cash balance sheets, providing significant opportunities for mergers and acquisitions and capital return going forward.

Companies like Keppel Corp, Sembcorp, ST Engineering and Singtel are among Maybank’s top heavyweight picks, while among its mid-tier calls are Genting, ComfortDelGro, Dyna-Mac, Frencken and Venture Corp. Singapore real estate investment trusts, or S-Reits, and property plays also look set to be beneficiaries of declining interest rates.

For the week ahead, consumer price inflation data for the United States, China and Tokyo will be in the spotlight and will be scrutinised for impact on monetary policy, which in turn could be a major driver of equity and bond markets in 2024.

Overall, however, the investment outlook for 2024 seems broadly favourable if disinflation continues without the US economy experiencing a hard landing, and if the Fed and other major central banks like the European Central Bank and Bank of England cut rates. 

However, do not expect markets to ascend in a straight line from here on. Expect intermittent pullbacks as several tail risks and uncertainties persist.