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All the key market drivers will have their moment in the spotlight this week, making this a potentially pivotal week for investors. Interest rates and earnings are top of the agenda, while here in the UK we wait for a Budget that, by recent standards, has been unusually free of leaks. That makes the UK’s flagship fiscal event a likely market mover too.
An old-style secret Budget
In recent years, it has become government policy to test changes to fiscal policy in the markets and media via a series of orchestrated leaks. This year, new Chancellor John Healey has adopted a more old-fashioned approach, keeping a lid on the Treasury’s thinking until he stands up in parliament on Wednesday lunchtime.
It is a promising run-in to a fiscal statement with clear goals - not to do any harm to a UK economy that is starting to perform rather better than the mood of gloom and doom might suggest, and to convince the bond market that this will continue to be the case.
The absence of leaks means the bond and currency market reactions on Wednesday will be important. With long bond yields approaching 6% in the UK, the government cannot afford to test the patience of the bond vigilantes. So far, they appear to be giving new Prime Minister Andy Burnham and his Chancellor the benefit of the doubt.
Also important will be the stock market reaction. In the absence of many fiscal options, business taxes could be in focus again, with an increase in the surcharge on bank profits seen as one of the likelier outcomes. The impact of the Budget on UK-exposed sectors like housebuilding will be closely watched.
Central banks in the spotlight
The Budget matters to us here in the UK, but for global investors it will be less important than the other two big drivers of markets, interest rates and corporate earnings. Both have a busy calendar this week.
The most important central bank will unveil its latest thinking on interest rates just a few hours after the UK Budget. The Federal Reserve is widely expected to leave US interest rates unchanged this week, with futures markets pricing in just a 9% chance of a hike. Although inflation is running ahead of target at 3.7%, the Fed is thought unlikely to move just days ahead of crucial mid-term elections.
The key driver of US inflation, the oil price, is anyway unimpacted by moves in the cost of borrowing.
Other central banks announcing decisions this week are also expected to sit on their hands. The ECB is weighing up rising inflation with the negative hit to growth represented by France’s ongoing unrest. There is some speculation that the ECB might intervene to keep a lid on French bond yields, which stand at a two decade high above 5%, but it has no mandate to interfere in domestic fiscal policy which lies at the heart of France’s woes.
Meanwhile in Japan, the Bank of Japan has steered investors towards a no-change decision on Friday. Although inflation is above target in Japan too, rates stand at a multi-year high in Japan already, and the principal driver of higher prices is, as in the US, beyond the central bank’s control.
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AI remains in focus
The other big driver of market volatility last week was the continuing wobble in investors’ enthusiasm for the AI boom. Markets have become increasingly sceptical about the returns that can be achieved on the enormous investment in AI infrastructure that has single-handedly fuelled GDP growth and market gains.
AI remains key to the earnings and valuation assumptions that are underpinning US equity markets and this week’s reports from Amazon, Alphabet and Microsoft will be scrutinised for evidence that the investment boom is running ahead of the industry’s ability to monetise the build-out of capacity.
What will matter is whether investors continue to reward earnings growth or start to punish higher capital expenditure.
Risk off?
Last week saw a classic risk-off move out of technology stocks and into more defensive parts of the stock market such as consumer staples, healthcare and energy and, crucially, back into safe Treasury bonds.
The yield on the 10-year US Treasury fell back below 5% after hitting a peak of 5.3%. Importantly, the move back into bonds did not reflect an easing of inflation fears but a focus on growth and a fall in real, inflation-adjusted yields.
Bonds have also started to look attractive in absolute terms in recent weeks. Pessimism among bond investors had reached extreme levels and valuations had become compelling, particularly compared to share prices which have baked in high and possibly unsustainable earnings growth.
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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