Tales of the unexpected

The Theodosiou household has been in a sorry state in the last couple of months. Chest infections, tonsillitis, sickness, and flus – some kind of unrelenting illness-relay has been passing its baton around the house with little sign of stopping. Certainly, as I watched the New Year’s Eve fireworks at the start of the year, I didn’t envisage such a difficult time ahead with everyone feeling so poorly, and it seems to be a widespread problem among friends and colleagues as we’ve started the year.

That said, I also didn’t expect financial markets to perform quite as they have. The theme of the first quarter of this year has been investors intently watching to see when US rate-setters might cut interest rates. General wisdom was that other major central banks, such as the European Central Bank (ECB) and Bank of England (BoE), would likely follow in the US Federal Reserve’s (Fed) large footsteps. But the US economy has consistently beaten expectations, and so expectations of Fed rate cuts have been pushed back. Unusually, risk assets have benefited, with stock markets buoyant on the idea that the US economy can perform even with interest rates at these levels.

Domestically, in recent weeks the tone seems to have shifted. Up until a few weeks ago, the prospect of the BoE cutting ahead of the ECB and the Fed had seemed fairly unlikely. But tepid economic data, unexpectedly quick disinflation, and a reasonably contained spring Budget led to the BoE’s Monetary Policy Committee (MPC) pivoting dovishly in March. In fact, the MPC’s two hawks shifted to vote to hold rates, with one voter continuing to call for an immediate cut. Currency markets digested the news and saw the pound weaken against its peers, while interest rate markets have adjusted to expect earlier UK cuts. For now, our economists retain their call for each of the Fed, ECB and BoE to cut first in June, but directionally it’s certainly been sterling-negative.

The pound held a very tight range against the US dollar and euro in Q1 compared to previous years. Like a spring coiling tighter and tighter as a relative calm has settled in, before a potential storm of interest rate adjustments in the months ahead that could see that spring jump into life. If the world has shown us anything in the last decade, it is to expect the unexpected, to not be complacent when sailing calm waters, and to always plan ahead for potential large market movements. It feels to me like we are reaching one of those turning points in the coming quarter. As the global economy recovers from a bout of high inflation in recent times, I can only hope the Theodosiou family can recover alongside it from a terrible case of Q1 fatigue.