Equity Markets Rally as ECB Raises Rates and Fed Pauses

Last week was dominated by decisions from two of the biggest central banks: the US Federal Reserve (Fed), and the European Central Bank (ECB).

While the Fed paused and did not raise rates (although it is expected to do so again at the next meeting on July 26th), the ECB raised rates by 25 basis points (bp) to 3.50%; with President Lagarde making it clear that more hikes are on their way.

This week will see the Bank of England (BoE) probably raise rates too.

Inflation Has Not Receded

It is the same issue everywhere. Despite having raised rates hard for the last year – admittedly from a very low base – inflation is not disappearing. Core inflation in the US barely moved month-on-month according to last week’s release (5.3% vs 5.5%).

Central banks were all hoping for a quicker deceleration. However, with full employment in the US, solid employment in Europe and persistent wage rises, inflation has not really receded.

The one issue complicating the assessment on the Fed’s reaction is Chair Powell’s seemingly ambivalent tone at the press conference. He could not quite explain why the Fed was pausing; at the same time hinting at further rate rises.

Health of Equity Markets is Debatable

This led fixed income to sell off further (all rate cuts expectations over 2023 have been unwound). But equity markets took the glass half full story in their stride as they rallied to new highs in Europe and closer to the highs in the US. On average, equity markets rallied by 1.75% last week.

The health of the equity markets is, however, up for debate. S&P and Nasdaq are led by only seven stocks that have performed extremely strongly, while the rest of the market is more or less flat. In other words, an acute dispersion.

The same story has been repeating itself every week for the last month, albeit incrementally with time. If one focuses on momentum then one should stay long. If one focuses on value then the assessment is that it is becoming unhedged, and prudence should rule.

Not an easy landscape.