Global markets ended the year on a positive note as momentum in financial markets continued. The main theme remained resilient economic data and slowing inflation, culminating in the US Federal Reserve signalling more rate cuts for 2024 than expected.
Share markets continued to rise, while US bond yields continued to move lower with the US 10-year rate moving down -0.45% to 3.88%. The expectation of lower rates and associated easing in financial conditions drove both bond prices and equity markets higher, with the S&P 500 up +4.4% in USD terms.
US inflation slowed as expected, falling from 3.2%. to 3.1%. The Federal Reserve (Fed) left interest rates unchanged, but signaled a potential 0.75% of cuts in 2024, which is 0.5% more than they projected in the September meeting. The forecasts also showed that no Fed members expect any further rate rises. As always, the Fed pointed out that the path of rates is data dependant, but they are comfortable that their tightening has done enough to bring inflation back down.
US interest rate markets had already been expecting cuts in 2024, but the surprise move by the Fed to acknowledge that more cuts are possible this year gave the market comfort the Fed is about to start normalizing interest rates.
The Reserve Bank of Australia (RBA) followed the Fed’s lead and left rates unchanged at 4.35% after hiking in November. The hold was widely expected by markets. The RBA noted they are seeing encouraging signs that inflation is easing, and they are happy to wait and assess data as it comes. Interest rate markets expect the RBA to remain on hold for the first half of the year before cutting in June.
In New Zealand, data continued to suggest that the economy is slowing. GDP contracted by -0.3% between June and September 2023, representing a -0.6% decrease from the previous year. The annualized fall in GDP was much weaker than the 0.5% of growth expected by the market. This downside surprise is in line with the negative sentiment around the economy coming from the higher cost of living and pressure from rising interest rates. The result is even weaker when adjusted for population growth, which would put the annual contraction at -3.1%.
As a result, the market expects the RBNZ to start cutting rates by May with over 1% of cuts priced in over 2024. The market seems to be pushing back on the RBNZ’s reluctance to lower domestic interest rates with global inflation slowing, NZ GDP falling and other central banks signaling potential cuts in 2024.
The shifts in interest rate expectations saw the 2-year rate decrease by -0.57% and the 5-year (being more influenced by global rates) decrease by -0.68%.
The increased expectation of US Federal Reserve cuts drove the USD down, pushing the NZD up 2.66% over the month.
While easing inflation and resilient economic data may continue, markets already appear to be quite convinced that a soft landing can be achieved. Investors will be keenly watching the flow of data to assess how likely a soft landing really is.