Prices are rising sharply on the stock exchanges. At the forefront: the German leading index. The DAX has gained double digits since October and is now approaching its previous record high. What’s going on there?
The leading German index is on the way to topping the record high it reached in the summer. The DAX is only around 300 points or just under one percent short of the record of 16,529 points from July. Since its October low, the index has gained a whopping twelve percent, including around nine and a half percent in November. The US stock exchanges are also going up strongly, with the Nasdaq technology index in particular rushing upwards.
There is a bet behind the price gains: more and more investors are betting that the central banks’ interest rate increases have come to an end – and that interest rates will even be lowered again in a few months. In order to get the severe inflation under control, both the European Central Bank (ECB) and the US Fed ended their years of zero interest rate policy last year and sharply increased key interest rates.
The mechanism behind it: Higher interest rates make loans more expensive and slow down both consumption and investments, which tends to dampen prices. However, it will take some time for the interest rate increases to have their full effect. As a rule of thumb, the duration is between 12 and 18 months.
Since October, the central banks have taken a break and have not raised interest rates any further. It now looks as if inflation on both sides of the Atlantic is under control again and is falling even without further interest rate increases.
Inflation is losing its terror
In the euro zone, general price increases fell to 2.4 percent in November, moving closer to the 2 percent target at which the central bank sees price stability achieved. In the USA, the inflation rate is 3.2 percent, which is also a sharp decline from the record levels last summer. Trend: continuing to fall.
At the same time, the European economy is weakening and, according to the Fed’s economic report, economic activity is also declining in the USA. This suggests that the central banks will soon lower interest rates.
Stocks generally benefit from the prospect of falling interest rates. On the one hand, they tend to stimulate the economy and thus enable higher profits for companies. In addition, when interest rates are lower, stocks become more attractive compared to forms of investment that pay interest. There is another reason, especially for tech stocks: due to sometimes very high liabilities and expensive investments, falling interest rates are a considerable relief for the industry. Against this background, the export-heavy DAX and the technology-heavy Nasdaq are among the indices that have made particularly strong gains recently.
The ECB is firmly sticking to the line of communication that interest rate cuts are not foreseeable. The latest inflation data is “good news” and a “positive surprise,” said ECB Vice President Luis de Guindos recently. But despite the sharp decline in inflationary pressure, there is still no reason to give the all-clear. Bundesbank boss Joachim Nagel, who likes to portray the image of the “greedy beast inflation,” repeatedly warned against prematurely declaring victory over inflation. It would be premature to cut interest rates any time soon or even speculate about such moves.
“Good arguments for easing”
Nevertheless, the financial market is increasingly expecting that the ECB will initiate the interest rate turnaround in April next year. A later date is currently assumed for the USA. Deutsche Bank, for example, expects the Fed to cut interest rates in June.
The central bankers in the USA are already cautiously preparing the markets for this possibility. Fed Director Christopher Waller said last week that there was a good case to consider easing if inflation continues to ease for a number of months. “If a high-ranking central banker like Waller sounds like that after stock and bond prices rose so sharply as in November, then that must now be considered the official line within the US Federal Reserve,” says Jochen Stanzl, chief market analyst at CMC Markets.
“However, whether the prevailing interest rate optimism will continue would also have to be confirmed by the economic side,” says Commerzbank. Economic data that will be published this week can therefore provide indications of further US interest rate policy. The focus is primarily on labor market figures from the private service provider ADP on Wednesday and the official US labor market report on Friday.