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I think the messaging from FOMC seems pretty strong and clear that stronger inflation would not stop rate cuts. What has been your reading because it seems like there are three to go this year itself?
Adrian Mowat: Yes, but remember the three to go is quite a bit less than the market was expecting at the beginning of the year. So the story seems to be one in which the US economy continues to surprise on the upside in terms of economic or momentum. The moderation, the sort of second differential that we had in our favour with declining inflation, does not seem to be there in the first quarter of this year, maybe not the first half.It is important to look at the dot plots from the Fed which are drifting higher in terms of their projections for this year, next year, and into 26. So, the narrative seems to be that the Fed was quite dovish, but there was hardly any move in the 10-year bond yield, and I think the move in equity markets if the Fed really was much more dovish than people were expecting would have been more dramatic than we saw overnight.
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You made a very interesting point as to how the markets did not quite have an exaggerated reaction if they were really reading a whole lot into the dovish commentary. What according to you is then the likelihood of these three rate cuts coming in for sure because I mean what if inflation does not cool down as per Fed’s anticipation?
Adrian Mowat: My bias would be that the risk is fewer than three rate hikes just in terms of looking at the economic momentum that we have in the US plus the fact that we are still well above the central bank’s target of 2% inflation. To me the biggest risk is coming from the bond market.
On Saturday the 23rd of March, if the yield curve is still inverted and it is 110 basis points inverted at the moment, that will be the longest period of yield curve inversion since the great depression. Now yield curves are inverted when you are expecting a recession but we just had the central bank of the United States coming out saying they are not forecasting a recession. There is an issue here.
Bonds are massively overvalued versus cash at this point in time and you resolve that either by bond yields going up or by short-term cash yields coming down quickly and there is nothing in the FOMC minutes or their summary of economic projections that would suggest that short rates are going to come down quickly and that means that the risk remains to capital markets as you get a selloff in bonds similar to what we saw in September and October 23.
What is the prognosis then for equity markets because yesterday we settled at a new record close. I know you anticipated a more exaggerated reaction if indeed the markets were reading a whole lot into Fed’s dovish commentary or thought it was dovish enough, but do you think this is a market which is running on its own steam?
Adrian Mowat: Yes, at the moment you have strong economic data, companies are reporting numbers that are above expectation and plenty of momentum in equity markets and the only obvious thing that could derail that is the bond market having a selloff which I was commenting on earlier on. So, for now, I suspect the trend is equities moving higher. There is an interesting trend developing in Asia that there is massive pessimism around China.
The macroeconomic data in China has turned out to be better than admittedly pessimistic views and at the company level you are seeing results exceeding expectations and companies announcing quite significant share buybacks and increases in dividends. I think there is a story of a broadening equity market. We have seen some good moves in global financials both in the United States and in Europe so it is moving away from just being driven by a narrow number of tech stocks.
So, the bull market continues unless we get a selloff in bonds and it is a story of a broadening, it is a broadening within sectors in the United States and I think it is a broadening to Europe, it is a broadening to possibly emerging markets beyond India which has been very strong and that is going to be the story for the sort of second and third quarter of 2024.
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