In the ever-evolving world of financial markets, investors and analysts alike often find themselves pondering a fundamental question: what truly drives the markets? Is it the invisible hand of policy or the tangible force of price?
The policy perspective
At first glance, it’s tempting to attribute market movements primarily to policy decisions. After all, when central banks speak, markets listen. The implementation of the United States (US) Federal Reserve’s (Fed’s) monetary policy, for instance, can send ripples through the financial landscape. Changes in interest rates affect borrowing costs, investment decisions, and, ultimately, stock valuations. Consider the dramatic impact of expansionary policies.
When governments open the fiscal floodgates or central banks cut interest rates, it’s like injecting adrenaline into the market’s veins. Stocks often surge as cheaper borrowing and increased spending boost corporate earnings. The post-Great Recession era serves as a prime example, with the S&P 500 more than tripling as the Fed slashed rates to zero.
But policy isn’t just about interest rates. Trade agreements, regulations, and even political events can shift market expectations and valuations. The uncertainty surrounding elections, for instance, typically increases market volatility. It is no wonder that investors keep one eye on the policy landscape and the other on their portfolios.
The price proposition
However, for all the attention policy receives, there’s a compelling argument that price is the true king of the market. At its core, the stock market is a vast auction house where the relentless forces of supply and demand determine prices. Technical analysts swear by price charts, believing that all known information is already reflected in the price. They argue that by studying price patterns, momentum, and trading volume, one can predict future market movements.
It is an enticing idea – that the answer to market behaviour lies in the price itself. Moreover, price movements can create their own momentum. Rising prices attract more buyers, pushing prices even higher, while falling prices can trigger selloffs. This self-reinforcing cycle can drive markets far beyond what fundamentals or policy alone might suggest.
The interplay of forces
In reality, the debate between policy and price is not an either-or proposition. The two forces are inextricably linked, each influencing and being influenced by the other. Policy decisions affect market prices, but prices also inform policy. Central banks closely monitor asset prices as indicators of economic health and inflation expectations. A sudden price crash might prompt policymakers to intervene, creating a feedback loop between policy and price.
Furthermore, both policy and price are subject to a myriad of other factors. Economic conditions, company earnings, investor sentiment, and global events all play crucial roles in shaping market dynamics. The 2006 to 2008 commodity price surge, for example, resulted from a perfect storm of dollar depreciation, strong global demand, supply shocks, and policy responses by major trading nations.
The verdict
So, what really drives the markets? The answer, unsatisfying as it may be, is both policy and price – and much more besides. Markets are complex adaptive systems, responding to countless inputs in often unpredictable ways. For investors, this means staying vigilant on multiple fronts. Keep an eye on policy developments, but don’t neglect price action. Study fundamentals but be aware of technical factors. And always remember that in the grand theatre of the markets, policy and price are just two actors in a much larger cast.
MARKET SNAPSHOT
Bonds
The 10-year US Treasury yield retreated below 4.55% following US President Donald Trump’s announcement regarding potential reciprocal tariffs and the relief in the market that he did not immediately move to impose those as initially threatened. In a week that saw not only a more hawkish Fed Chair but also higher-than-expected inflation data from the US, investors seemed to prioritise these geopolitical concerns over the hotter-than-expected inflation data.
In contrast to the US, the United Kingdom’s (UK’s) 10-year Gilt yield climbed to a two-week high of 4.556%. This surge was primarily driven by stronger-than-expected gross domestic product (GDP) data, which showed 0.1% growth in the fourth quarter, defying economists’ predictions of a contraction.
Meanwhile, German Bunds saw their yield retract to 2.47% as optimism about a potential end to the Russia-Ukraine war is increasing.
Equities
US stock futures remained steady, with major indices posting gains on Thursday. The Dow Jones Industrial Average rose 0.77%, while the S&P 500 and Nasdaq Composite climbed 1.04% and 1.5%, respectively. Investors largely overlooked the stronger-than-expected inflation reports, focusing instead on positive corporate earnings and the delayed implementation of tariffs.
The UK’s FTSE 100 underperformed its European counterparts, falling 0.49%. This decline was primarily attributed to weak corporate earnings, with notable drops in cigarette and tobacco manufacturer British American Tobacco, multinational consumer goods company Unilever, and global financial services company Barclays.
The German DAX Index reached a new record high, closing sharply higher at 22,612. This marked the fourth consecutive day of advances, which saw it outperform its peers. The rally was fuelled by strong corporate earnings and optimism over a potential end to the Russia-Ukraine conflict.
Commodities
Brent crude oil futures rose to around $75.20/barrel, supported by the delay in President Trump’s reciprocal tariffs on US trading partners and a more optimistic outlook from the International Energy Agency. Despite hitting their lowest levels since late December on Thursday, crude prices are on track to post a slight gain for the week.
Gold held firm around $2,920/ounce, remaining near recent record highs as it heads towards its seventh consecutive weekly gain, which will be its longest positive run since 2020.
Currencies
The US Dollar Index continued its recent decline to around 107 and is on track to lose about 1% for the week. This weakness is primarily driven by components of the Producer Price Index (PPI) data (although the overall PPI reading was higher than expected), which contributes to the Personal Consumption Expenditure (PCE) Index, the Fed’s preferred inflation measure, which was softer.
The euro climbed above $1.04/€ to a two-week high, benefitting from reduced concerns over swift US retaliation on tariffs following President Trump’s tariff review announcement. However, monetary policy divergence between the Fed and the European Central Bank continues to pose headwinds for the currency.
Sterling rose to $1.25/£, buoyed by better-than-expected UK GDP data. However, challenges persist, with the Office for Budget Responsibility set to release an updated economic and fiscal outlook later this month.
Key indicators:
GBP/USD: 1.2563
GBP/EUR: 1.1995
GBP/ZAR: 23.20
GOLD: $2,928
BRENT CRUDE: $75
Sources: Refinitiv, Reuters, Bloomberg and Trading Economics.
Written by Citadel Advisory Partner and Citadel Global Director, Bianca Botes.
© Peregrine Wealth Ltd
This publication has been compiled for information purposes only and does not take into account the needs or circumstances of any person or constitute advice of any kind. It is not an offer to sell or an invitation to invest. The information and opinions in this publication have been recorded by Peregrine Wealth Ltd in good faith from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness or correctness. Peregrine Wealth Ltd accepts no liability whatsoever for any direct, indirect or consequential loss arising from the use of this publication or its contents. Peregrine Wealth Ltd (registration number 39538) is licensed by the Guernsey Financial Services Commission.