Central Banks surprise the markets

Last week, over 10 central banks provided updates. In the US, the Fed left its target for the Federal Funds rate in the range of 5.25%–5.5%. The still-elevated inflation of 3.7% is the main reason why the Fed continues to signal its readiness to hike interest rates. However, we expect a cooling economy and the further easing of the labour market to make another rate increase unnecessary and stick to our view that the Fed is done with hiking rates.

In Japan, the monetary policy stance remains ultra-expansive. The Bank of Japan held its policy rate unchanged at a negative -0.1% and kept its recently watered-down yield curve control in place. The Bank of England (BoE) surprised markets by holding its bank rate at 5.25%, against market expectations of a hike to 5.50%. A strong drop in inflation and recently weak growth data caused the Monetary Policy Committee to shift to a narrow 5–4 vote in favour of the hold. We believe that the BoE has concluded its tightening and will keep the base rate at its current peak until the second half of 2024 to ensure that inflation recedes sustainably towards the 2% target.

The Swiss National Bank held its key interest rate at 1.75%, against a market consensus of a last 25bps hike to insure against a possible uptick of inflation in the coming months.

What happens after the rate hikes stop?

Looking at previous end-of-tightening cycles since the early 1970s, the evidence suggests that equity returns tend to be good following the last rate hike. In 8 out of 11 instances, S&P 500 returns were positive over the next 12 months after the last rate hike. In those three instances when equity returns were negative, it coincided with the US economy moving into a recession near the end of the tightening cycle, which we don’t see as the case this year.

At the margins, financials tend to do well after the last rate hike, while commodity-related and consumer-cyclical stocks tend to underperform the broad market. For now, we continue to recommend focusing on large-cap quality growth names, mixed defensives and investing in the future (information technology, engineering, communications).

Investing in the future: renovating and modernising real estate

Real estate is the world’s biggest store of value, worth around USD 300 trillion according to real estate company Savills. This is more than the equity and bond markets combined, and it is aging quite rapidly in Europe.

In Europe’s premier cities, such as Berlin, London, and Paris, the average age of residential buildings is more than 70 years. Looking beyond their age and the related need for renovations, buildings account for almost 40% of global greenhouse gas emissions. Two-thirds of these emissions occur from operations, because of the electricity consumed and the heat generated. Another third is ‘embodied carbon’, relating to the emissions that were generated during the production phase of building materials, most notably concrete, glass, and steel, and the construction phase of the building.

The optimisation of energy efficiency and a shift to clean energy supplies provide the strongest levers to make our buildings more sustainable. Meanwhile, the decarbonisation of building materials is in its infancy due to mindset barriers and the lack of scale of available innovative solutions. As a result, we see a very sound opportunity for investments in building technology, for both ecological and economic reasons.

What does this mean for investors?

Going forward, our economists expect policy rates to remain on hold until Q3 2024 before a further rate-cutting cycle begins. Since the winter months generate better returns, on average, than the summer months, investment opportunities abound in autumn 2023.

Quality European bonds have joined the crowd of safe-haven bonds, enjoying upside from the halting of rate hikes. We also continue to see a strong trend and reiterate our constructive view on investing in future cities. This includes segments such as electrical engineering, insulation, heating, ventilation, and air conditioning, as well as broader building technology solutions.