All eyes on the Fed - the week ahead

There’s no doubt about the market’s main focus this week. After 10 months sitting on its hands, the Federal Reserve is expected to cut interest rates for the first time this year. And that’s fuelling new highs for shares all around the world.

Global bull market

The US remains in the vanguard of the rebound from April’s tariff-related market volatility. But the rest of the world is joining in the party. Three quarters of stocks in the MSCI All World global index are trading above their 200-day moving average. Momentum is strong.

In part that’s a bet on lower interest rates. But it also reflects continuing belief in the AI transformation narrative. It’s why shares in Asian markets - home to much of the world’s computer chip industry - are leading the charge. Japan, South Korea and Taiwan all ended last week at new highs.

• Read: 3 handpicked funds to invest in Japan

As always when markets surge, it’s a combination of rising earnings and higher valuations that’s driving the gains. The US market has risen nearly 90% since the October 2022 low, with around a third of that due to higher profits and two thirds a reflection of shares trading on a higher multiple of earnings.

The end of Fed independence?

A key reason why investors are so optimistic about lower interest rates is the expectation that the Federal Reserve is losing its independence from the US government. For more than 70 years, the Fed has focused exclusively on inflation and growth when setting interest rates. But pressure is mounting on the central bank today to set policy to suit the government’s desire for lower borrowing costs on its sky-high debts.

With Fed chair Jerome Powell due to stand down next May, investors expect his replacement to be much more amenable to the President’s desire for lower interest rates. With core inflation remaining sticky, it remains to be seen how far interest rates can actually fall but for now markets are assuming that the direction of travel is lower.

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Party like it’s 1998?

With the Fed set to cut rates even while the stock market is soaring, students of market history will note a worrying reminder of the late 1990s internet boom, when the Fed also poured fuel on a smouldering market fire. The result was a two year melt-up in stock markets. It ended badly but only after an exciting ride for technology-focused investors.

Back then, other signs of market froth included a booming IPO market as companies sought to cash in on high valuations. And a related rise in share-funded mergers and acquisitions as companies took advantage of the rising value of their shares to buy other companies relatively cheaply.

On both fronts there are few signs of excess today. But last week was the best week for US market flotations in four years as companies from buy-now, pay-later business, Klarna to crypto exchange Gemini raised a combined $4bn from investors.

• Read: Can I invest in cryptocurrency within my ISA?

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Not all good news

So, there’s plenty for investors to get excited about this week, but a few clouds on the horizon too. Here in the UK, inflation data is expected to emerge at twice the Bank of England’s 2% target. An inflation rate of 4% may not sound a huge problem but, as we explain here, it would wreak havoc with investors’ retirement plans if allowed to continue. And it makes it hard for the Bank of England to follow the ECB and Fed lower on the interest rate front - an issue for the government with long bond yields standing at a 30-year high.

Meanwhile, over in France, a gaping mismatch between tax revenues and spending - particularly on pensions - has left the French government having to pay more to borrow than some large French companies. That’s a very unusual state of affairs and a sign of how far France has drifted from the heart of the Eurozone to the economic periphery, alongside countries like Italy and Greece.

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• Read: Why it pays to understand the bond market
• Read: How 4% inflation could derail your retirement
• Read: What can we expect in the Autumn Budget?

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