This week in the markets - all eyes on interest rates

There’s plenty to keep investors on their toes this week with key interest rate decisions on both sides of the Atlantic, an ongoing rotation out of the market’s tech stock leadership and into smaller companies, and a flood of earnings announcements.

Will they, won’t they?

Both the Federal Reserve and the Bank of England will decide whether to cut interest rates this week. The odds are thought to be shorter on a rate cut over here than in the US, where the smart money remains on a September pivot towards easier monetary policy.

The Bank of England has kept interest rates at 5.25% since last August, a position that’s looking harder to justify now that inflation has been at the 2% target for two months on the trot. Rate-setters are concerned that persistent service sector inflation and wage growth threaten to push the headline rate higher later in the year when lower energy and food costs drop out of the year-on-year comparisons.

Service sector inflation stands at 5.7%, much higher than the Bank would like. Wages too are growing at the same pace, despite a recent rise in the unemployment rate to 4.4%. So, the Bank of England’s decision on Thursday remains on a knife edge as it errs on the side of caution.

Over the pond, the Fed is thought unlikely to move on Wednesday but to tee up a first rate cut for its next meeting in September. Interest rates in the US stand at a 23-year high of between 5.25% and 5.5% but the Fed has also worried about persistent inflation in the face of a red-hot labour market which is only just starting to cool.

Round and round

In the stock market, the main focus continues to be the rotation out of the Magnificent Seven stocks which have led the market higher since the low point in October 2022 and into smaller companies which have been left well behind during the market rally.

In the nearly three weeks since a lower-than-expected inflation print in the US cemented hopes for an imminent pivot in the interest rate cycle, the market rally has broadened out significantly. While the Magnificent Seven stocks have fallen by 12% and the S&P 500 by 3%, the equal weighted US benchmark has risen by 3% and the Russell 2000 small cap index is up by 10%.

Comparisons are naturally being drawn with the bursting of the dot.com bubble in 2000 but the latest rotation feels very different. Then, the market pushed to an unsustainable new high despite 80% of stocks being in a downtrend. Today, the same proportion of shares are rising. So, while the headline index is struggling, many investors are seeing the value of their portfolios rise.

Earnings deluge

The key driver of stock markets is earnings growth, so attention will rightly shift this week to the torrent of results announcements on both sides of the Atlantic. In the US, three more of the big tech stocks announce - Microsoft, Apple and Amazon. Those results will be key in determining whether the rotation into the rest of the market continues.

But there are plenty of results in other sectors too, with the likes of McDonalds, Procter & Gamble, Starbucks, Kraft Heinz, Mastercard, ExxonMobil and Chevron also in the spotlight. Meanwhile over here we can look forward to quarterly updates from L’Oréal, Rio Tinto, Danone, Barclays, Rolls-Royce, Volkswagen and Shell, among others.

And finally…

While investors will be focused on the market impact of interest rates and earnings, their personal financial position may be just as influenced by what the new Chancellor Rachel Reeves has to say this week. She is taking the opportunity in the final week before parliament’s summer recess to set out what she describes as the previous government’s ‘failure’ to manage the public finances.

She will set out a £20bn shortfall between tax revenues and funding commitments that many fear could be a precursor to tax increases in her first Budget, scheduled for October after the party conference season.

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