Most of the major indexes ended higher for the week, with the S&P 500 Index and Nasdaq Composite rounding out on Thursday their best monthly gains (8.9% and 10.7%, respectively) since July 2020. Falling Treasury yields seemed to continue to boost sentiment. In local currency terms, STOXX Europe 600 Index ended 1.35% higher, as a steep decline in inflation and falling bond yields lifted investor sentiment. Major stock indexes rose as well. Germany’s DAX climbed 2.30%, Italy’s FTSE MIB tacked on 1.69%, and France’s CAC 40 Index added 0.73%. The UK’s FTSE 100 Index gained 0.55%.
Japan’s stock markets fell over the week, with the Nikkei 225 Index declining 0.6% and the broader TOPIX Index down 0.4%. Japanese shares were subject to some profit taking after rallying in November on expectations that U.S.
Chinese equities retreated as official indicators underscored concerns about the country’s fragile recovery. The Shanghai Composite Index gave up 0.31% while the blue-chip CSI 300 lost 1.56%. In Hong Kong, the benchmark Hang Seng Index fell 4.15%
Falling Treasury yields seemed to continue to boost sentiment, and a broad index of the bond market recorded its best monthly gain since 1985. The 10-year Treasury yield traded at its lowest level since mid-September, falling by 20bp over the week to below 4.3%. The two-year yield declined more than 30bp towards 4.6%, its lowest since mid-July, leading to a slight steepening in the yield curve. Fed fund futures currently predict a near 90% chance of a rate cut by mid-2024.
UK gilts rallied despite a hawkish tone from Bank of England (BoE). UK bond yields declined as dovish sentiment prevailed, with the 10-year gilt yield falling to 4.18%.
The German 10-year bund yield was down about 20bp over the week, reaching 2.40%, its lowest level for four months. Both Italian BTP and French OAT 10-year yields fell by a similar amount. Annual inflation in the eurozone fell to a lower-than-expected 2.4% in November, down from 2.9% last month.
The 10-year JGB yield fell by almost 10bp over the week to 0.71%, its lowest level since mid-September. This was despite a jump in the Bank of Japan (BoJ)’s favoured measure of inflation – weighted median inflation – to an annual rate of 2.2%, an increase of 20bp over the month, which was the largest rise since records began in 2001.
Topic in focus – Is there a chance to battle recession in UK?
It’s hard to look at the UK and not to feel concerned. While each region and country face its own challenges, the UK seems to be accumulating them. Indeed, domestic inflation remains stickier despite the continued surge in interest rates seen in the last twelve months. With labour supply still constrained, the job market’s tightness is still problematic and raises the prospects of a wage-price spiral embedding higher inflation expectations. In one word, the UK economy exhibits all the trademarks of stagflation. That said, just like the rest of the world, the economy has been much more resilient than expected a year ago. But here again the positive surprise could be attributed to overly pessimistic assumptions about 2023 made back then, rather than stronger economic momentum.
Table 1. UK economic forecast
Source: Barclays
The UK economy is on track to deliver growth of 0.5% in 2023. Without any signs of improvement in leading indicators, it’s hard to envisage a stronger showing in 2024. In fact, it is expected that gross domestic product (GDP) will expand by just 0.4%. While a UK recession will probably be avoided in the coming months, just like its eurozone neighbour, the margin for error is small. On the positive side, consumption should remain supported by wage growth and a long normalisation process for the job market from the effects of the COVID-19 pandemic. On the negative side, this will likely keep inflation elevated for longer than the Bank of England would like. As a result, the “plateau” of higher interest rates may extend until well into the later parts of 2024 before dropping significantly.
After peaking at above 11% twelve months ago, headline inflation has been on a steep downtrend in 2023, rapidly approaching 6%. Meanwhile, core prices (or those excluding volatile items like food and fuel) have been stuck close to these levels for the best part of a year. There are good reasons to believe that inflation will ease more quickly. First, with economic growth stalling for a second year, companies’ ability to pass on higher prices to shoppers should be much tougher. Second, some cracks are starting to appear in the job market: the unemployment rate has risen to 4.3% in the three months to July, from the 3.8% seen in the previous three-month period. Furthermore, vacancies dipped below one million in the summer, after peaking at 1.3 million in May 2023. This should encourage lower wage growth and help to bring the consumer prices index below 3% in 2024.
Consumers, businesses, and investors face the difficulty of judging the likely outcome of a general election seemingly pencilled in to take place in the fourth quarter of 2024. The opposition Labour party is well ahead in the opinion polls and appears to be on course for a victory. A possible change in the administration can be a source of both hope and uncertainty and electoral campaigns are often rich in headline-grabbing promises, whether these translate into law. But elections also breed uncertainty at a tough time for the country, economically speaking. Whoever comes to power will face the harsh reality of public borrowing fast approaching 100% of GDP, having doubled in the last 15 years. Any incremental public spending is unlikely to be financed through hiking the deficit further. In other words, higher taxes might be on the cards. Given the limited certainty over what the political landscape will look like a year from now, the risk is that businesses and consumers alike turn cautious, adopting a “wait and see” attitude. This could hamper spending at a time when the UK economy is already failing to generate meaningful growth. With so many unknowns and with risks tilted to the downside, the outlook for the domestic economy is far from exciting. That said, as seen in the last twelve months, it’s much easier to surprise positively when expectations are so low.