This week in the markets: Shares bounce back on hopes for peak interest rates

After three months of drift - building up to a 10% market correction since July - shares have bounced back strongly. Investors took heart from dovish comments from the Federal Reserve and weaker than expected job creation. They are daring to hope that the fabled ‘soft landing’ is back on the cards.

Shares and bonds rally together

Investors have enjoyed gains across the board as the Federal Reserve and Bank of England held interest rates and provided a broad hint that we have reached the peak of the current tightening cycle. The good news was compounded at the end of the week by news that the US economy created only half as many jobs last month as it had in September.

That’s counter-intuitively good news for markets because it points to a gentle slowdown rather than a recession. It suggests that the Fed may have navigated us towards a so-called soft-landing in which inflation is tamed but recession averted.

Bonds, which have endured a painful couple of years of rising interest rates, snapped back sharply, with the two-year Treasury yield now safely under 5%. Bond yields move in the opposite direction to prices so falling yields are good news for investors. At the same time, the S&P 500 rose by nearly 6% on the week, dragging markets in Europe higher too.

The good news is that the market rebound was broad-based.  Many sceptical investors felt that a market rally that was wholly dependent on a handful of big tech stocks was unsustainable. So, it is encouraging to see the equal-weighted S&P 500 index, and smaller cap stocks too, enjoying the better market sentiment.

One other piece of good news is that we have safely navigated the traditionally difficult months of September and October. As we head into November, average returns tend to improve and investors are now looking hopefully towards the so-called Santa Rally, which often lifts prices in the run up to Christmas and into the New Year.

But inflation remains on the radar

Stepping back to look at the bigger picture, however, it’s clear that inflation remains a concern. While the headline inflation rate is falling back (albeit less so here in the UK), longer-term rate expectations are continuing to edge higher. That raises the spectre of a re-run of the 1970s when heavy government spending and a strong economy led to spiralling wages and prices.

Things are different today. Central banks are more attuned to the dangers of cutting rates too quickly at the first sign of economic weakness. But investors are rightly concerned about inflation. Outside of a sweet spot of between 1% and 3%, the valuation of the market tends to fall as investors fret about persistent inflation or deflation.

Higher inflation also leads to a greater correlation between shares and bonds. They move in the same direction, which makes portfolio returns choppier and reduces the benefits of diversification. When our investment returns are more volatile, we are more prone to make expensive mistakes.

Coming up this week

Monday - The week begins with results from German biotech firm BioNTech and budget-airline Ryanair.

Tuesday - The British Retail Consortium-KPMG publishes its latest retail sales monitor. There are results from Primark-owner Associated British Foods, Direct Line, Metro Bank and UBS.

Wednesday - Inflation data is out for Germany. There are results from Marks & Spencer, ITV, Walt Disney, and JD Wetherspoon.

Thursday - Today, China’s latest inflation figures are out. A busy day for results with AstraZeneca, Flutter Entertainment, National Grid, Taylor Wimpey, Tate & Lyle and WHSmith reporting.

Friday - The week ends with the UK gross domestic product (GDP) figures and results from Allianz and Redrow.

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. Please be aware that past performance is not a reliable guide indicator of future returns. 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.