The strong market development that has continued since the start of the year took a major blow last week with the USA’s weak labour market data and the Fed’s decision on the key interest rate. Investors have also started to turn away from tech stocks, which have long dominated the market.
The summer has been very eventful, and the future of the markets appears different now than when the holiday season started. The rise of the equity markets took a break in July and finally collapsed in several market areas at the end of last week. The collapse turned the full-year returns of Japan’s Nikkei index negative in one fell swoop, and over the weekend, the VIX index, which measures price fluctuations on the stock market, rose to more than double the figures of last week.
The weaker-than-expected labour market data in the USA came as a surprise to the market, although indicators have long shown that the labour market is trending down. It now appears that we are moving from a decrease in job vacancies to an increase in unemployment.
In addition, structural changes have been seen within the stock markets during the summer. Tech companies, which achieved good momentum, have lost their popularity, while dividend shares and shares with low price volatility have become more common as investment objects. Demand for safe havens is increasing.
The US yield curve, i.e. the 2- and 10-year government bond interest rate difference, which has been negative for a historically long time, has also turned upwards towards a “normal” level. In terms of the growth outlook, the direction of the curve is not good – historically, an upward turn in the interest rate curve has almost always signalled the beginning of a recession. On the other hand, the actual economic figures and preliminary estimates of economic growth in the first half of the year in the USA have been positive and, for example, the latest PMIs were still reasonably strong. The idea of a recession therefore does not seem likely, at least right now.
During the summer, the fixed income markets have been more consistent than the equity markets, with high-risk high yield corporate bonds and senior loans in particular performing well.
The Western world, with the exception of Japan, is expected to shift into a period of easing monetary policy during the autumn, when the Fed is expected to make its first decision to lower the key interest rate. The market was disappointed when the Fed did not cut interest rates at its meeting at the end of July, and expectations of rate cuts have clearly risen in the USA. Investors are now expecting interest rates to be reduced as many as four times by the beginning of 2025, and that the September interest rate movement will be as much as 0.5 percentage points.
Inflation has levelled off in both Europe and the USA, but the two percent target level has not yet been reached. Inflation appears to be stuck at three percent, which is clearly lower than last year’s peaks but still too high for the central banks’ goals. Moreover, prices are on average several tens of percent higher than a few years ago, which significantly affects the position of the consumer.
In Europe, economic growth is slower than in the USA and inflation is at a slightly lower level, which further increases the ECB’s pressure to continue lowering interest rates in the autumn. There is no room for significant interest rate cuts, however, unless there is a significant slowdown in economic growth.
The USA’s lead in growth prospects narrowed during the summer compared to Europe and China, but is still clearly ahead. However, the US consumer’s position is a concern for the market, especially as the labour market cools. And in Europe, industry remains stalled.
Investors should also keep an eye on the market movements caused by the US election in autumn. The country’s politics experienced a colourful summer, and the situation is unlikely to change as the election approaches. It is difficult to predict the actual impact the election will have on the markets, but in the short term, price volatility may increase.
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