Amid persistently high inflation rates, particularly in the US, and with investors eagerly watching for potential interest rate moves by the Federal Reserve later in the year, one cannot help but recall the adage, “If all you have is a hammer, everything looks like a nail.”

However, we should remember vividly the decade following the Great Financial Crisis of 2007/08, during which neither zero nor negative interest rates were able to bring about higher inflation. Deflationary forces were too strong at play.

To the same extent, higher policy rates alone are also not capable of immediately pushing down elevated inflation levels. Central banks’ interest rate policy is just one of many levers for altering the general price level of an economy. In media-savvy presentations, there is often talk of the “4D’s” that are held responsible, depending on whether inflation rates are deemed too high or too low:

1. Deglobalization; 2. Demographics; 3. Decarbonization; 4. Debt

The widely pursued goal of a 2% annual inflation rate – explicitly declared in the United States only since 2012 – is rarely questioned and has now become almost sacrosanct. In truth, the determination of a central bank’s interest rate policy is about gaining or maintaining the trust of the population and investors in the currency as a store of value compared to real assets. In other words, even in monetary policy the principle applies: “perception is more important than reality.”

Market Review Year-to-Date

After five consecutive positive months, the stock markets paused in April. In the US, the benchmark S&P 500 index declined by 4.2% in April, but still posted a gain of 7.5% year-to-date. Similarly, the technology-heavy Nasdaq Composite retreated in April but remained 7.6% higher than its level at the beginning of January. The MSCI World index rose by 6.1% year-to-date.

In Europe, the Euro Stoxx 50 advanced by 8.8%, while the relatively defensive Swiss Market Index has only gained 1.2% year-to-date in 2024.

Against the negative global trend, China and Hong Kong stood out in April. Year-to-date, the Shanghai Composite rose by 4.4% and the Hang Seng by 8.4%. Even stronger performance was seen in Japan, where the Nikkei 225 surged by 14.3% in 2024 so far.

The prices of most 10-year government bonds declined year-to-date, indicating a rise in long-term interest rates. For example, the yield on 10-year US Treasury benchmark bonds increased from 3.87% to 4.51%, while those on 10-year German Bunds rose from 2.03% to 2.49%. In Italy, the increase was more moderate, from 3.71% to 3.80%, leading to a significant reduction in the widely monitored spread compared to German bonds. Even in Switzerland, where the Swiss National Bank (SNB) initiated a cycle of interest rate cuts, yields did not decrease but remained at 0.70% for the 10-year Swiss “Eidgenoss” bond.

In Japan, the yields on 10-year government bonds rose from 0.62% to 0.90%. However, in China, amidst a pronounced real estate crisis and a noticeable economic slowdown, the yields on 10-year government bonds decreased from 2.58% to 2.31%.

There were significant price movements in commodity markets. Since the beginning of the year, gold and silver have risen by 11.5%, Brent crude oil by 7.5%, and the price of copper has increased by 17.4%. However, cocoa prices have seen by far the largest jump, surging over 90% year-to-date. On the other hand, natural gas has managed to narrow its losses in recent weeks but still remains at the bottom of the table with a decrease of 14.5%.

Over in currency markets, the dominant themes were the strength of the US dollar and the pronounced weakness of the Japanese yen. Year-to-date, the greenback rose against the JPY by 8.5%, against the CHF by 7.6%, and against the EUR by 2.5%. Additionally, the three major commodity currencies – the Canadian dollar (Loonie), Australian dollar (Aussie), and New Zealand dollar (Kiwi) – all lost ground against King Dollar since the beginning of the year: USD/CAD +3.3%, AUD/USD -2.9%, NZD/USD -4.9%.

The outlook for risk assets has softened somewhat

Until the summer months, we anticipate limited advances in equities, particularly in the US market. On one hand, positioning in US benchmark S&P 500 index futures shifted from strongly negative net positions during April to positive, which typically serves as a reliable contrarian indicator. On the other hand, historical data in the US since 1949 indicates that in election years following a positive first quarter, the months of April and May have tended to be negative on average, before resuming a positive trend in the last seven months of the year.

Currently, market reactions to inflation and economic data appear relatively straightforward and, to some extent, rational: lower inflation and weaker economic data tend to lead to increases in stocks and bonds (with lower interest rates), as this is seen as paving the way for imminent interest rate cuts. Conversely, higher inflation and stronger economic data are viewed negatively, as hopes for interest rate cuts are pushed further into the future. One almost gets the impression that the sword of Damocles of interest rate expectations looms over every market movement, exerting its hypnotic effect on market participants. However, at some point, real economic conditions are likely to regain control. It will be intriguing when market reactions deviate from the aforementioned script.

In equities, we maintain a neutral stance. As a hedge against geopolitical uncertainty, the risk of overly tight monetary policy, and potential economic downturns, we are strategically positioned in gold, gold mining stocks, and long-term government bonds.

We anticipate that inflation in Europe will decline more significantly than in the United States. Therefore, the ECB is likely to lower interest rates at its upcoming meeting on June 6, while the first interest rate cuts by the US Federal Reserve are expected to occur in September, or possibly not until November or even December.