Lower US inflation sends share markets roaring ahead
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What’s just happened?
US equities reached new highs last night, with the S&P500 racing ahead 1.2% and the technology-focussed Nasdaq surging 1.4%.
US Government 10-year Treasury yields fell steeply, finishing down 0.10% at 4.35%, (bond prices rise when yields fall).
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Why?
April’s US consumer price index fell to 3.4% from 3.5% the previous month. Core inflation which excludes the more volatile food and energy items eased to 3.6% from 3.8% in March.
Both were in line with economists’ forecasts, but the news was greeted with a collective sigh of relief by markets.
The first three monthly inflation reports of 2024 exceeded expectations, raising fears that interest rates would need to remain elevated for longer than investors had previously expected. This had led to the sell-off in global equity markets in April.
Yesterday’s inflation news was viewed by markets as confirming inflation will fall back down to the US Federal Reserve’s 2.0% target without further rate rises. This is seen as being consistent with a ‘soft landing’, with futures markets now pricing in two 0.25% cuts in US interest rates this year from their current 23-year high of 5.25% - 5.50%.
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What does this mean for investors?
Such an economic environment is viewed by investors as more favourable for global equities. Expectations that interest rates may begin to fall later this year brings down longer-term bond yields – as we saw last night. This lowers the equity discount rate which analysts use to value the future profits of companies, which tends to support the share price of most stocks.
Growth stocks whose earnings lie further out into the future tend to benefit disproportionately from this adjustment and often outperform as bond yields fall.
Similarly, smaller company valuations are especially sensitive to interest rate levels and often outperform when interest rates are cut.
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