Week in the markets: when will interest rates start to fall?

With interest rates continuing to be the main driver of stock markets, the eight weeks in the year when the US and UK central banks announce rate decisions are among the most important for investors. 

No change, but not no news

The Federal Reserve is the key focus this week as it unveils its latest thinking on interest rates on Wednesday. The odds of a first rate cut this month are tiny (about 3%, according to financial futures markets) but that doesn’t mean the Fed’s meeting is not important. 

That’s because a big gap has opened up between what the central bank is saying about rate cuts (three this year) and what the market expects (five or six). With plenty of scope for disappointment if the Fed errs on the side of caution, Jay Powell’s comments after the rate decision will be crucial. 

Over here, there is also little chance of a change in direction. In fact, the Bank of England is still talking in public about the possibility of raising rates if inflation stays high. But that is looking increasingly implausible and the direction of travel for rates is the same here as over the Atlantic, even if the timing may differ slightly. The Bank’s decision is due on Thursday. 

UK inflation remains higher than in the US and Europe but it’s falling fast, and cheaper energy in the spring has the potential to bring price rises back to target as much as 18 months sooner than the Bank expected only recently. Mortgage rates below 4% are already pointing to a rapid retreat from today’s 5.25% base rate. 

Tech’s turn

Meanwhile on the earnings front, the fourth quarter results season gets into full swing this week with earnings announcements from a long string of companies, including five of the so-called Magnificent Seven. Apple, Amazon, Alphabet, Microsoft and Meta will all update shareholders, who will be looking for good news to justify the recent strong rally in the tech sector’s share prices. 

More broadly, earnings season has got off to a reasonable start. With around a quarter of results now in the bag, about 80% of them have been better than forecast by an average of 6%. That sounds good but it’s actually the norm for companies to beat carefully managed expectations. The scale of the beats is a bit lower than in recent quarters and that raises some doubts about whether the 11% growth pencilled in for 2024 as a whole is realistic. 

Earnings growth is a prerequisite of further progress for the market because valuations have risen quite a lot since the October 2022 low point. US shares are now priced at 20 times expected earnings, up from 15 at the market low. Other markets are much less stretched, with the UK, for example, on about 11 times earnings and Europe not much more. 

China: if not now then when?

One market where valuations are definitely not demanding is China where investors have voted with their feet over the past year. If you’d invested £100 in China 12 months ago you’d have just £70 today versus £120 if you’d backed the US market. A huge divergence in a short space of time. 

This week the news seemingly got even worse, with a Hong Kong court ruling that Evergrande, the world’s most indebted property developer, should be wound up. But China is so out of favour that it is possible that the Evergrande news could mark peak pessimism. Reasons to think a change in fortunes is imminent include a more favourable regulatory environment, more stimulus from the authorities in Beijing and, most importantly, very cheap valuations. Chinese shares are priced at less than 10 times expected earnings.

For more on rates expectations, see our interest rates round-up which is updated weekly. Or sign up to Pulse for regular updates on rates. 

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Please be aware that past performance is not a reliable guide indicator of future return. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.