With this outlook in mind, markets partied hard. From 5% in late October 2023, 10-year Treasury yields fell all the way to 3,8% by the end of the year, while stock markets (particularly US markets) rallied.
Unfortunately, the assumptions underlying the outlook for interest rates have proved to be a little too rosy.
Inflation has proven resilient and has yet to reach the Fed's 2% target. However, economic activity has remained strong, particularly in the fourth quarter. Market participants have had to adjust their expectations to just 2-3 interest rate cuts in 2024. This adjustment provided less lift to the economy. However, given economic solid activity figures, it still looked manageable, and investors got solace from knowing that interest rates would eventually fall.
The last few weeks have been harder. With inflation picking up somewhat and growth fading to just 1,6% for the first quarter (versus 3.4% in 4Q23), investors have had to adapt their expectations again for 2024. They’re now betting on just one interest rate cut in 2024, or perhaps even no interest rate at all.
That higher for longer mantra has impacted investor confidence: 10-year yields are back near 4.7%. Stock markets have also been less enthusiastic lately but have found comfort in the AI euphoria and have had good first-quarter results.
On the Forex front, the fact that the Fed is now much less likely to lower interest rates in 2024 has supported the USD that has gained against most other currencies.
On the bond front, rising interest rates have led to falls in bond prices in most markets.
The one exception has been China. Still, on a completely different growth cycle from the rest of the world, China continues to stimulate its economy, and interest rates are expected to continue falling. In principle, lower interest rates in China than in the USA should lead to a falling currency. However, Beijing appreciates stability and sees yuan strength as a badge of honour, as it wants other countries to perceive the foreign currency as an alternative to the greenback. Hence, it is currently intervening to stop the yuan from depreciating, and given its vast reserves, it looks likely to have the capacity to do so for a prolonged period.