Week in the markets: investors shrug off new inflation fears

New Year, new fears. The Santa Rally has faded in the memory and investors are starting the New Year with a different set of concerns. In the markets there is always something to worry about, but for now investors are continuing to see the glass as half full.

Where next for inflation?

The most important risk for investors is a rekindling of inflation fears as key shipping lanes in the Middle East are threatened by attacks by Houthi rebels on tankers entering the Red Sea bound for Suez and US-led retaliatory strikes on their positions in Yemen.

The Red Sea is the most important choke point for shipping lanes that account for around 15% of global sea trade, including 8% of grain and 12% of seaborne oil. Volumes in the region are currently running 70% below usual for early January. Worries about the economic impact of diverting ships around South Africa lie behind the decision by the US and UK to hit back.

The actual economic impact may be limited. Companies will adapt to longer delivery times as the journey from Asia to Europe and the east coast of America may take up to two weeks longer to complete. And shipping costs are relatively low for high-cost items like consumer electronics.

More important could be the cost of oil if the Israel/Gaza war spills over into a broader regional conflict. The price of a barrel of Brent crude has risen above $80, although robust supplies and slowing demand as major economies flirt with recession suggest that here too the impact could be limited.

Inflation will be a focus in markets this week with CPI data due in the UK, as well as Germany and Japan. In the UK, the key driver is expected to be a recent drop in the cost of wholesale gas which suggests that current inflation forecasts for 2024 could be too high.

With the UK no longer the inflation outlier that it was throughout last year, expectations for lower interest rates are firming, with a drop to perhaps 4% by the end of the year looking plausible. Goldman Sachs has already pencilled in 3% for the middle of next year.

New year, new highs

The expected drop in interest rates is one reason for a number of stock markets around the world hitting new highs in the early weeks of this year. Japan is not quite there but stands within a whisker of the all-time high the Nikkei 225 reached on the last day of 1989, at the height of Japan’s property and stock market boom. New corporate reforms are driving increased optimism that Japanese shares could move into new record territory soon.

Meanwhile, the Indian stock market continues to move into uncharted territory, with the Nifty 50 index breaching 22,000 for the first time ever as investors warm to India’s economic prospects. Always one of the most highly valued emerging markets, India now trades on a par with the popular US market at around 20 times expected earnings.

And finally….

Politics is very much on the market agenda in 2024 and a year of intense electoral action has already got underway. In Taiwan, the pro-sovereignty Democratic Progressive Party (DPP) secured a third term in power. Meanwhile in the US, the year long election campaign gets underway this week with the first caucus in Iowa against a backdrop of sub-zero temperatures. At this early stage it is not clear who the two contenders will be in November, but Donald Trump and Joe Biden remain the favourites, again, to represent the Republicans and Democrats.

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