With only a few weeks left until the end of 2023, many international investment banks have started publishing their initial forecasts for next year.

2023 can be best described as a year when the extent of the interest rate hikes surprised many economists and investment banks given the persistent high levels of inflation. Despite this major headwind, equity markets recovered from the sharp downturn in 2022. In fact, the S&P 500 index rallied by over 15 per cent so far this year although this was mainly driven by the so-called ‘magnificent seven’ (Amazon, Apple, Alphabet, Meta, Microsoft, NVIDIA and Tesla) as a result of the enthusiasm for artificial intelligence (AI). Collectively, these seven companies generated spectacular returns during the year and an index measuring their performance shows year-to-date gains of just over 100 per cent. Since these seven companies account for almost 30 per cent of the overall S&P 500 index, the strong upturn in their share prices propelled the US benchmark index to double-digit gains this year to move not far off from the all-time high of 4,800 points in January 2022. The importance of the performance of the technology companies to the overall movements in equity markets can be seen from the Nasdaq 100 index which is up 40 per cent year-to-date. Despite the strong outperformance of US-based technology companies, European equities also performed positively in 2023 with the Euro Stoxx 50 also up about 15 per cent so far.

Bond markets performed negatively for the second consecutive year in view of the consistent hike in interest rates for 11 consecutive times with the Federal Funds rate increasing to 5.5 per cent since the end of July (the highest level since 2001) and the deposit rate of the European Central Bank (ECB) rising to four per cent since September. Moreover, recent comments by the major central banks that in the future, rates will remain ‘higher for longer’ sent yields to fresh multi-year highs some weeks ago.

The 10-year US Treasury yield jumped from a 2023 low of about 3.3 per cent in April to five per cent in late October — the highest level since before the global financial crisis in 2008. Likewise, in Europe, the 10-year German bund yield recently touched a level of 3 per cent – the highest level in more than 10 years.

However, publication of better-than-expected inflation numbers in the US earlier this month showing that core inflation rose at the slowest annual pace since September 2021 provided strong signals that the Federal Reserve will very likely not pursue further rate hikes. Equity markets rallied following the publication of this important data while bond yields dropped remarkably signalling firmer bond prices. In fact, the 10-year Treasury yield in the US eased below the 4.4 per cent level compared to the multi-decade high of just over five per cent only a few weeks ago while in Europe, the 10-year German bund yield dropped back to below the 2.5 per cent level which represents a sharp downturn from the recent multi-year high of 3 per cent.

This latest inflation report in the US altered expectations of monetary policy movements in the months ahead which as I stated in one of my recent articles, remains one of the most important drivers for all asset classes.

In fact, many economists have now shifted their views on both the timing of the initial cuts in interest rates by the major central banks and how many cuts will be announced during the course of 2024.

In the US, the timing of the first interest rate cut has now been brought forward to May 2024. Some analysts predict that the Federal Reserve will announce four rate cuts in 2024 with the Federal Funds rate being slashed by a total of 225 basis points to 3.25 per cent from the current level of 5.5 per cent. One major bank in particular expects a more aggressive easing of US monetary policy with a 2024 year-end Federal Funds rate target of only 2.75 per cent. Should the Federal Reserve adopted such a policy, one would expect a strong performance for the US bond market as the 10-year US Treasury yield is predicted to decline to 3.7 per cent by the end of 2024.

The ECB is predicted to announce rate cuts totalling 100 basis points in 2024 sending the deposit rate facility back down to three per cent. One investment bank in particular opined that the ECB may commence the easing of monetary policy earlier than the Federal Reserve which may cause European yields to fall earlier than those in the US. The 10-year Eurozone bond yield is anticipated to ease towards the 2.3 per cent level by the end of the year which would imply a recovery in bond prices including Malta Government Stocks which generally move in tandem with changes in eurozone bond yields.

Movements in interest rates by the major central banks will undoubtedly also impact the performance of equity markets. A number of prominent investment banks expect another strong year in 2024 for the US equity market. Some expect the S&P 500 index to surge to a record high of 5,000 points (the previous high was of 4,796.56 points on 3 January 2022) while two investment banks are even more bullish and seem to agree that the S&P 500 index will climb to 5,100 points by the end of 2024, implying a potential upside of over 12 per cent from current levels.

Although the outlook still remains very uncertain, it has become evidently clear over recent weeks that the threat of inflation is passing quicker than central banks suggest and as such, the monetary policy tightening cycle has virtually come to an end in various parts of the world. It is also likely that the beginning of the subsequent monetary policy loosening is closer than central banks are currently indicating. Upcoming inflation readings and statements by central bank officials will continue to have important and wide implications for all asset classes especially if central banks will cut rates by more than the market is currently anticipating.

Given this backdrop, some of the global wealth management companies are encouraging investors to consider ‘locking-in’ the relatively high yields now available in various currencies in anticipation of a reduction in bond yields next year.

Read more of Mr Rizzo’s insights at Rizzo Farrugia (Stockbrokers).

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