Global shift in rate cut bets sparks Santa rally

“Markets never go up in a straight line, and it will be volatile, but we definitely think we have seen the lows of the [current cycle] and are entering a new bull market.”

Australian equities are tracking the surge on Wall Street that has pushed the Nasdaq 100 and blue-chip Dow Jones Industrial Average to new highs, and the S&P 500 index within 0.6 per cent of its record set in January last year.

Further jawboning from Fed officials has done little to dent the market’s exuberance. It comes despite Atlanta Fed president Raphael Bostic saying there is no urgency for the US to lower borrowing costs, and predicting just two rate reductions in 2024 – well below market expectations.

‘Way too aggressive’

As of Wednesday afternoon, Fed futures indicated around 150 basis points of rate cuts next year – equivalent to six reductions – and ascribe an 84 per cent chance that monetary easing will begin in March.

In Australia, futures imply just a 3 per cent chance the Reserve Bank will lift the cash rate to 4.6 per cent at its first policy meeting of 2024 in February.

Financial markets are fully priced for a rate cut in August and ascribe a 91 per cent chance of a second reduction by December next year. The RBA’s cash rate is at 4.35 per cent.

Some bond fund managers do not share the sharemarket’s enthusiasm for an easing.

“The markets are way too aggressive in the timing and scale of rate cuts, both in the US and Australia,” said Tano Pelosi, a portfolio manager at Antares Capital. “Their pricing of cuts suggests a significantly weaker period of economic growth and potentially a recession.”

Even so, investors around the world are feeling the most optimistic in a year, according to Bank of America’s fund manager survey, which was conducted between December 8 and December 14 (the day of the Fed’s rate decision).

They also hold the least amount of cash in their portfolio in two years, and have the biggest overweight to equities since February 2022.

Their risk-on stance comes despite half of the 254 respondents, who oversee $US611 billion ($904 billion) in assets, expecting global growth to weaken next year, while about a third tip the US to fall into a recession.

“Markets always climb a wall of worry,” Mr Hickson said, noting that this time last year investors were also expecting a “significant” recession in 2023. “The economy has been a lot more resilient than everyone expected.”

Year to date, the S&P 500 has soared 25 per cent, buoyed by expectations of easier monetary policy but also investor enthusiasm for artificial intelligence and the so-called Magnificent Seven mega-cap tech stocks.

In contrast, the resources and banks heavy ASX 200 has rallied a more modest 8.5 per cent. Over the past month, however, the gauge has outperformed in Australian dollar terms, climbing 7.1 per cent versus a 1.4 per cent gain for the major global indices.

The strength of the $A has helped. The currency was trading at a five-month high of about US67.74¢ as rate-cut hopes weighed against its US counterpart. Minutes from the RBA’s last policy meeting also revealed the central bank had considered lifting the cash rate this month.

Capitulation

While the Australian dollar has rebounded more than US2¢ in just two weeks, it’s still on course to post a 0.7 per cent decline for the year.

The Fed’s pivot in the last board meeting for the year has turned even the most steadfast Wall Street bears optimistic after chairman Jerome Powell revealed that rate increases were “not the base case any more”.

The bond market has responded in kind, with US 10-year yields tumbling to about 3.92 per cent, down from a peak of 5 per cent in mid-October.

“We have seen US 10-year bond yields fall over 50 basis points in the last six weeks which is highly supportive of [stock] valuations and provides a significant tailwind to the economy next year,” 1851 Capital’s Mr Hickson said.

In Australia, the 10-year government yields have shed nearly a full percentage point since the start of November to 4.07 per cent, while the three-year return, which is sensitive to the rate outlook, has shaved off 76 basis points to 3.72 per cent, the lowest since early September.

Antares’ Dr Pelosi is among a cohort that still expects the RBA to raise interest rates once more next year, to 4.6 per cent, but he also concedes that central bank could hold fire if rates fall elsewhere in the world.

“If the Fed does cut rates in 2024 and leads the global policy rate cycle down, it’s very difficult for a small open economy and central bank like in Australia to be hiking in that environment,” he added.

Fund manager Nathan Parkin of Ethical Partners expects the RBA to keep rates higher for most of next year and cautioned that equities were “riding high on the fumes” of COVID-19 stimulus. Consumer spending, he said, would return to more “normal levels” in 2024.

KMD shares fell 8 per cent to 70¢ on Wednesday after the Kathmandu parent said group sales were down 12.5 per cent in the first four months of the new financial year.

“People are trying to extract the last little bit of earning growths, so next year’s reporting season is when you will start seeing what is really going on out there,” he told the Financial Review, adding that his fund was “becoming more defensive the further [the rally] goes on”.

With Jonathan Shapiro