The great rate hangover

Stocks continue rising while bonds take a breather
Interest rate cut expectations held back
Chinese economic woes continue
The resurge of India

Financial markets took largely diverging paths during the last month, as global stocks continued their march forward, while bond prices somewhat retreated on the scaled back interest rate cut expectations. One of the major catalysts for such market dynamic were mostly resilient macroeconomic data from major regions, ongoing excitement about the artificial intelligence (AI) business case, as well as the dominance of companies perceived to be related to AI in the US stock market.

As a result, developed markets’ stock index MSCI World has increased 4.1%, while emerging markets stocks’ index MSCI Emerging Markets has jumped by 4.6%. During the same period yields on bonds have increased slightly, with 10-year US Treasury bond yields rising to 4.25% (compared to 4% 1 month ago) and German 10-year bond yields increasing to 2.41%, up from 2,17% a month ago.

Interest rate expectations rolled forward – bonds retreat

During the final months of 2023 the substantial part of market participants were expecting the first interest rate cut to take place as soon as 2024 March, thanks to rapidly decreasing inflation, resilient-yet-subdued economic activity, and some encouraging remarks from the central banks themselves - first and foremost, the Federal Reserve (FED). So far, the culmination of such consensus has peaked in the final days of the 2023. That narrative with the arrival of 2024 has been taken slightly off the aggressive track lately, as the multiple data points have shown more bustling economic activity, than previously expected. Interestingly, the inflation figures in recent months have come out slightly higher than expected, too. Even if it’s down to technical reasons (e.g. the timing of fiscal measures), it appears to be contributing to a timely consolidation in the otherwise aggressive bonds’ rally since November. Even though it is likely that the rates have already reached their peak, central banks will most likely stay cautious with their further guidance and will be eager to wait for the data to confirm the future moves.

China’s woes continue

As millions of Chinese have been bracing for the Lunar New year celebrations in February, investors in the stock market of the second largest economy in the world had little to celebrate this year. During the last few years investors in Chinese equities have had to endure the zero-Covid policy-induced slow GDP growth, regulatory crackdown on the prominent private Chinese businesses and individuals, the ongoing real-estate bubble saga and the over-arching background of increased geopolitical risks, thanks to increased competition with the US and escalated rhetoric from the Chinese leaders towards Taiwan. This troublesome cocktail has given multiple reasons for market bears to push down the value of the CSI 300 index (see Chart) significantly, while the rest of the world has largely stayed bullish. February was noted by the court ruling that Evergrande – the second largest real estate developer in the country – should go into liquidation, as no success in debt restructuring talks has been achieved. Chinese stocks remain relatively cheap when compared to its peers, but the investors will most likely be overly curious to see the next moves how country will navigate the multiple challenges it faces before coming back.

India roars back

Just as China has been facing its own challenges, another emerging markets’ star – India – appears to attract have attracted increased investor attention, lately. The country has not only recently overtaken China as the most populous country in the world (with population of 1,4 bn set to rise further vs expected decline in the Chinese population). India’s economic growth appears to be charging forward, too, as the economy is expected by OECD to showcase the largest economic growth among the major countries (6,2% and 6,5% in 2024 and 2025, respectively). As the country seems to be finally putting itself firmly in the global supply chains and heavily investing in the much-needed infrastructure, some analysts are expecting India to become the third largest economy by 2027, overtaking Japan and Germany along the way. Finally, worn down by the geopolitical drama of the Chinese market, investors appear to appreciate India as a “western-friendly” emerging market alternative with the jubilant economic activity to bank on. On the other hand, the excited investors have pushed up the valuations of Indian equities rather high quite quickly, recently (see Chart). Hence, it offers investors the long-forgotten excitement about the emerging market economy with high valuations and many potential pull backs along the road in the future.

Chinese and Indian stock market returns since 2020, %

Source: Investing.com

Market view

As the financial markets are pondering on their aggressive rate cut expectations, some asset classes (notably, bonds) are taking the breather before setting the further trend. The prevailing narrative of the “soft landing” seems to be offering support to continued strength in equity prices along with the hope that central banks will be coming back to concrete plans on interest rate reductions later this year.

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