RBC Market Update – Week ending April 12, 2024

 

The past few weeks have seen an increase in activity across global equity, fixed income, commodity, and currency markets, marked by an increase in volatility. Two developments were particularly noteworthy. The first is a significant shift in U.S. interest rate expectations due to recent inflation data. The second concerns heightened geopolitical tensions in the Middle East, following the Iranian and Israeli attacks on each other, which has left investors pondering the potential impacts on financial markets.

Nearly a week ago, Iran launched an attack on Israel using hundreds of drones and missiles, reportedly in response to an Israeli strike in Syria earlier this month that killed several members of Iran’s armed forces. While Israel successfully defended itself against the attack, it represented an escalation in tensions as it was the first direct attack by Iran on Israeli soil. More recently, Israel has retaliated with an attempted strike that appears to be confined to military targets in Iran. Oil prices, have not surprisingly been volatile over the past few weeks as investors try to gage the severity of this escalation and the risk of further destabilization in the region.

From a market standpoint, the more influential developments have been on the inflation and interest rate fronts. The U.S. inflation data for March showed that, for a third month in a row, inflation in the U.S. was no longer easing, and in some areas was reaccelerating. The stubbornness of inflation pressures presents a dilemma for the U.S. Federal Reserve, which had earlier expressed growing confidence that it would be able to cut rates at some point this year. But over the past week, a number of Fed officials have acknowledged the need for patience before taking any action on rates. Consequently, market expectations have also changed dramatically from anticipating up to seven interest rate cuts in the U.S. to now expecting as few as one to two. This recalibration has driven bond yields higher (and bond prices lower), while stock markets have also trended downward recently, albeit relatively calmly, as investors grapple with the prospect of prolonged higher rates potentially affecting growth and corporate earnings.

Meanwhile, the U.S. dollar has rallied against most other major currencies, including the Canadian dollar. There is a growing view that central banks in Canada and other regions may start cutting rates by the summer, while the U.S. may not act until later this year at the earliest. That would lead to a widening of the differences between interest rate levels across the regions, which has traditionally been a driver of currencies.

We haven’t been terribly surprised by the shift in interest rate expectations. And we’re not convinced it fundamentally alters the investment outlook. Our approach continues to lean on a few high-level views. First, higher bond yields have improved the return potential for bonds, providing us with a more useful tool for some of our client portfolios. Second, we believe equities face a range of outcomes over the next few years that is a bit wider than normal, stemming from the rapid series of interest rates hikes over the last few years. That said, it’s clear that the U.S. economy has demonstrated less sensitivity to interest rate increases than other regions thus far, supporting its equity market. Nevertheless, we are managing our asset allocation positioning more carefully than usual given the macroeconomic backdrop.

Thanks for tuning in and see you in two weeks.