What goes up, must come down…

The stock market rally that sent the Dow Jones to a record high has halted for now, and US stocks had their largest daily loss since October and September on Wednesday. This has permeated sentiment during the European session on Thursday, with European stocks also coming under downward pressure. There was no notable risk off driver to send stocks lower, however, there is a fear that markets have got too far ahead of themselves and thus a pull back is necessary. It is also worth noting that sovereign bond yields, which have had a mega rally in recent weeks, saw a mini pullback, with the 10-year Treasury yield rising by 2 basis points to 3.87%. However, the pullback in stocks may not last, as e-mini futures for the S&P 500 are rising again before the US open on Thursday.

Elsewhere, the UK is in focus, after a much larger than expected drop in CPI for November. The annual headline CPI rate was 3.9%, down from 4.6% in October. The core rate of inflation also fell to 5.1% last month, down from 5.7%. This is a global trend, and we have seen similar disinflation in Europe and the US, and the UK government will be happy that the UK is no longer an outlier. Anecdotally, much of the downward pressure on inflation could be down to discounts from retailers, as they try to shore up customer loyalty and ditch profit led inflation, ahead of what is expected to be a tough year for the UK economy. However, there are two points that are worth making at this time of year: firstly, UK inflation has probably been overstated due to the ONS failing to capture supermarket loyalty programme discounts in their official data, and secondly, the UK is well used to dire economic forecasts and has managed to evade the worst of them in the post-covid era.

One of the biggest problems that the UK economy faces is its current account deficit and its debt load. While expectations that interest rates will fall are helping to reduce interest costs, UK 10-year Gilt yields are at their lowest level since April and 5-year fixed mortgage rates are now below 4%, so debt appears to be a problem for another day. Of course, it’s not really a problem for another day, as the UK continues to rack up enormous amounts of debt, but the mood music has changed and some of those negative economic outlooks for the UK may be too morose as we start the new year. Although public sector borrowing was £14.3bn last month, more than the £12.9bn forecast by economists, this was lower than the November borrowing rate in 2022. This has boosted hopes of a modest tax cut in the Spring budget. Tax receipts were also higher last month, up £3.6bn on 2022 to £77.6bn, this was the highest tax take for the month of November since records began. Strong wage growth has helped to push more people into higher tax brackets, which is fuelling larger tax receipts.

Financial markets don’t tend to move on the back of monthly public borrowing figures, especially since this release had something for everyone, including the naysayers and the cheerleaders for the UK economy. Overall, the fall in bond yields is helping to brighten the outlook for the UK economy next year, and if this continues, or if 10-year bond yields remain closer to 3.5% than 5%, then we may see some upward revisions for the UK economy in 2024, especially if retail sales show some bounce for November, they are released on Friday.

Ahead today, US Q3 GDP will get its second release, the market expects no change at 5.2%, so we do not expect a large market reaction. Instead, we think that the Japan inflation reading for November will be a more interesting release later on Thursday. The market is expecting a drop in national core CPI to 2.5% from 2.9%, suggesting that the disinflation trend could also be spreading to Japan before the BOJ has managed to end their negative interest rate policy. The BOJ meeting earlier this week did not signal that rate increases are coming in the immediate future, and this helped USD/JPY to recover back above 142.00 earlier this week. In fairness, the move was fairly small, so we could see a larger recovery in the USD if we see weaker than expected Japanese inflation when it is released later on Thursday.

Overall, the day-to-day market movements this week could be impacted by low volume, as traders take time off for the Christmas holidays. However, 2024 is gearing up to be a big year, so don’t miss our predictions for next year that will be coming out in the next few days!