Market snapshot: sentiment fragile yet mostly optimistic

Markets continued to grind higher as the headwinds of the Middle Eastern conflict were neutralised by a further softening of rhetoric from the Federal Reserve.

Alongside the human tragedy was some hope that the violence could be contained and that diplomatic efforts to resolve the conflict could yet wash through. Having spiked the previous day, oil and gold prices stabilised, although there was some evidence of investors seeking haven assets.

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Having been closed on Monday, the US bond market had its first opportunity to react to developments, with a buying surge lifting prices and therefore depressing yields.

This in turn underpinned some strength in equities, with further Fed comments adding to the optimism. Among the speeches from top Fed officials were observations from one that there was no need for further rate rises and that he saw no recession ahead.

Another member echoed the comments from colleagues the previous day that yield levels were currently obviating some of the requirement for further rate hikes, while there was also some speculation that the 2% inflation target would be achieved without a damaging effect on the unemployment rate.

The news resulted in a balance of around 75% of traders now estimating that there will be no further rate increases this year, most likely ending the hiking cycle once and for all. The debate would then move on to just how long rates would need to remain at these elevated levels, with the likelihood of rate cuts next year currently lessening as the Fed maintains its “higher for longer” mantra, as could be evidenced by the imminent release of the latest Fed minutes.

The week will continue to throw challenges at investors, where sentiment remains fragile. Producer and consumer price index readings are due over the next couple of days, while the new earnings season begins in earnest at the end of the week as the banks reveal their current trading positions.

Overall, hopes for the earnings season are that companies in general will have swung back to year-on-year growth, particularly among the larger corporates with the ability to protect margins by passing on some of the prevailing cost increases. Equally, outlook comments will also be scrutinised, especially with regard to the vitally important consumer where any signs of weakening sentiment given the tighter economic environment are likely to be punished.

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In the meantime, the cautious improvement in sentiment enabled further gains for the main US indices, with the Dow Jones now ahead by 1.8%, the S&P500 by 14% and the Nasdaq by 30% in the year to date.

The disparity in the performance of the indices has been largely driven by mega cap technology stocks, where the potential of Artificial Intelligence has captured the imagination of investors, and where any updates on its progress in this quarter would be warmly welcomed.

Asian markets were also higher overnight on rumours of stimulus measures in China likely to land shortly, but the general sense of global optimism did not filter through to the UK. The premier index opened marginally lower, with retailers and housebuilders among the early casualties following an attempted relief rally over recent days, leaving the FTSE100 ahead by just 2.2% in the year to date. 

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Meanwhile, the FTSE250 continued to trade in negative territory for the year, currently down by 5.2%, with the most recent warning on prospects for the UK economy coming from the International Monetary Fund.

The likelihood of interest rates staying higher for even longer given a particularly challenging battle with inflation is an idiosyncratic but real challenge domestically. In the meantime, anaemic growth and an increasingly cautious consumer could potentially add to a toxic economic mix.