A new hope

Cautious optimism was the dominant mood across markets this week after a series of positive inflation reads and forecasts in the world’s major economies. 

In the U.S., April’s Consumer Price Index (CPI) reading came in at 3.5%, the first time in four months the data was in line with economists’ expectations. This renewed hope of early central-bank action to cut interest rates prompted the S&P 500 Index to close above 5,300 for the first time and brought year-to-date returns to 11.3%.

A similar story played out in Europe, where the region’s Stoxx 600 Index closed at a record high after updated estimates from the European Commission suggested inflation will fall faster than previously expected. 

The Commission’s revised forecast points to a decline in annual inflation to 2.5% this year before hitting the European Central Bank’s (ECB) 2% target in the second half of 2025. This is an improvement on its February forecast, in which it said the decrease would be to 2.7% in 2024 and 2.4% in 2025. 

Chris McGinley, portfolio manager and head of trade finance at Federated Hermes, points to a decline in shipping lane disruption in the Red Sea as one reason for the revised projections. Attacks by Houthi rebels operating out of Yemen have led shipowners to reroute cargos away from the Suez Canal and around Africa instead. This longer route can add to journey times and push up costs. “However, so far, the impact has been milder than some people feared and it looks like this has fed into the lower-than-expected inflation numbers in the eurozone,” says McGinley.

Louise Dudley, portfolio manager, Global Equities at Federated Hermes Limited, notes the upbeat mood across markets, adding that inflation data, and the timing of central bank interest rate cuts would continue to be the key catalysts. 

“We see a U.S. cut in September and December priced in and so are paying close attention to CPI, unemployment, and GDP read-outs,” she said. “We still expect the Federal Reserve (Fed) to require consistency in the data, and don’t expect them to pull the trigger too early. We cautiously expect one interest rate cut this year but expect volatility to hit if inflation remains sticky and unemployment is hot.”

What scope for policy divergence?

Orla Garvey, senior fixed income Portfolio Manager at Federated Hermes Limited highlights the theme of fiscal and monetary policy divergence between the U.S. and other major economies. The latest iteration is the upswing in growth in the eurozone and the U.K. and a slight stalling of momentum in the U.S. This does not mean that it will be easy for the ECB or the Bank of England (BoE) to take a separate path from the Fed, however. 

“We think the ECB and BoE can loosen monetary policy to an extent and we do expect a series of cuts from both central banks this year,” she says. “Outside of that, it becomes more of a delicate balance as persistent dollar strength might be a concern—as would the impact on the external account from higher U.S. rates.”

Despite the generally upbeat mood, Garvey sounds a note of caution. “While the data is beginning to paint a positive picture, this latest equity charge is more on the side of optimism, and there are still multiple hurdles to overcome before we have a clear picture,” she says. “We expect sensitivities to data prints to grow as we move closer to September.”