Following the latest series of major central bank meetings, there's a growing consensus that the current rate-hike cycle might have reached its peak.
As policymakers such as the US Federal Reserve, Bank of England and those at the central banks of Japan and Switzerland opt for a steadying hand, the financial markets are buzzing with anticipations and strategic recalibrations.
Last week's decision by the BoE’s monetary policy committee to hold its base rate at 5.25%, despite elevated UK inflation but against a background of slowing economic growth, has definite implications for the equity market, UBS strategists said.
They noted the relief rally in interest rate-sensitive stocks on the day of the MPC meeting, such as housebuilders, banks and consumer-facing companies, underscoring the broader concerns about a potential recession.
"However, with the growth backdrop expected to stay weak for several months yet, concerns about slipping into recession will likely play on the share prices and valuations of cyclically sensitive stocks such as UK banks," said strategist Caroline Simmons.
Despite "very attractive" valuations for banks, she said, "until there is more evidence on how much weaker the economy will get, we prefer the safer, more defensive and more global consumer staples-related areas of the equity market".
Energy is a UK sector Simmons also highlighted as "looking attractive", given the supply-demand imbalances in oil and the "attractive" valuations of the stocks.
"While the energy sector has already outperformed, following oil prices higher in recent weeks, our view that the Brent crude oil price will stay around US$95 per barrel over the next 12 months should provide further support, allowing investors to focus on companies' attractive dividends and ' share buybacks."
Overall, for the FTSE 100 index, the strategist saw a combination of a bottom being reached in earnings and a "slight re-rating potential" as bond yields start to move lower over the next few months in light of slowing GDP growth and inflation.
"This leads us to anticipate a rise in the FTSE 100 to 8,200 by June 2024," Simmons said, with UBS forecasting the index will offer a dividend yield of around 4%.
When are rate cuts?
Since the BoE pressed pause, with the US Fed having already been on a stop-go-stop strategy, strategists and economists have also been recalibrating their expectations of when central banks will start to cut rates again.
The BoE is likely to keep bank rate unchanged at 5.25% throughout the rest of 2023, said economist Kallum Pickering at Berenberg, who forecasts a first cut comes in the second quarter of 2024.
Berenberg forecasts that by end of next year we could see a 4.0% base rate from the BoE – implying 125 basis points of total cuts next year.
Presently, the market for overnight index swaps (OIS) anticipates around 25bp in cuts in 2024.
"Via lower costs of mortgages and consumer credit, a shift down in benchmark rates consistent with our view would be positive for the real economy and risk markets," Pickering said.
But he sees upward pressure on benchmark and money market rates in the near-term, due to the pace of tightening alongside the ‘higher for longer’ guidance.
"However, markets are likely to lower their bets for the path of bank rate early next year as economic weakness and a further fall in the pace of inflation forces the BoE to turn less hawkish and begin to lay the ground for rate cuts probably from spring onwards."
With the world about to shift into "a new monetary era" as central banks lean towards rate cuts as growth slows and inflation eases, Nigel Green of deVere Group said investors need to make sure they begin to reposition their portfolios appropriately.
Green suggests investors need to recalibrate their portfolios towards companies that display resilience during downturns.
“These are companies that tend to exhibit resilience during downturns due to the essential nature of their products or services. Sectors like healthcare, utilities, and consumer staples often fall into this category. Companies in these sectors can continue to generate revenue even when consumer spending weakens."
For more growth, he mentioned that emerging markets present attractive opportunities during periods of global economic slowdown, as they often exhibit higher growth potential compared to mature economies but come with higher volatility.
At Jefferies, chief European economist/strategist Mohit Kumar said for equities, "the medium-term macro outlook is challenging" with central banks in the camp of higher for longer and economic data expected to turn.
In the medium term, he said "it calls for a cautious stance... However, we believe that short term risky assets can do OK and this is not the start of a downturn".
As investors are underinvested, more economic "bad news would be good news", as it indicates central banks are not going to hike anymore, so for equities and other risky assets, "we would focus on relative value in the near term", with an 'overweight' stance on US tech as a long-term trade.
"We favor US over Europe, as data is already showing clear signs of weakness in Europe. We remain skeptical on the China stimulus and remain of the view that a large scale stimulus would not be forthcoming," he said.
At Liberum, the strategy team were among those predicting that it will be the second half of 2024 before rate cuts arrive.
"We remain bullish on equities in Q4 2023 but expect market weakness in H1 2024 before a recovery in H2 2024, driven by accelerating GDP growth and central bank rate cuts," said Liberum's Joachim Klement.
Like Green, Klement's sector preference is for a "shift to defensives, with technology and commodity stocks improving throughout 2024".
He sees Threadneedle Street cutting by 50bps in 2024, the Fed to cut by 100bps and the ECB to cut by 50bps.