June 17 2022
There are some weeks when news and events come thick and fast and this has most certainly been one of them. Central banks were once again at the fore, with a number of them holding meetings this week. The US Federal Reserve were first to act, with a 0.75% rate hike. Initially, a 0.5% lift had been expected, but after the higher than expected inflation print last Friday, coming in at 8.6% versus 8.3%, the market began to anticipate that this might just be on the cards. Inflation had not been expected to rise and certainly not to this extent, raising concerns that it was becoming more entrenched in the economy than expected. They now forecast that PCE inflation will be 5.2% for 2022 versus their March forecast of 4.3%. It is, however, expected to roll over in 2023, with a rate forecast of 2.6%. The latest dot plot now shows a median expectation for the Federal Funds rate of 3.25% by year-end and 3.75% by the end of 2023, before falling back in 2024 and beyond. The dispersion of expectations however remains wide, in particular for 2023 and 2024.
The Swiss National Bank also met this week and caused something of a stir. They had been expected to keep rates on hold at -0.75% but took the market by surprise with a 0.5% hike and did not rule out further increases at future meetings. Their inflation forecast was not as aggressive at that of the US, with a rate of 2.8% for this year, but this was significantly higher than their previous forecast of 2.1%.
Last but not least the Bank of England also met. Given the size of the US move, there were some who thought that the Bank of England may take advantage and hike by 0.5%. Instead, however, they stuck to the 0.25% rise, taking the base rate to 1.25%, the fifth consecutive hike. The vote however was not unanimous, with six members voting in favour of 0.25% and three in favour of 0.5%. The Bank now forecast that inflation could peak at c.11% in October before it starts to fall. This is some way above the current average earnings growth (excluding bonuses) of only 4.2%, taken in April. The rate hike comes despite the economy contracting in April for the second consecutive month.
Whilst the ECB did not meet to discuss rates, having done so last week, an emergency meeting was called to discuss the potential for a new “anti-fragmentation instrument” which could be implemented to try and ensure that borrowing costs are consistent across Eurozone members. The hawkish monetary policy stance now taken by the ECB to combat inflation has led to divergence across member state bond yields. Peripheral bond yields have risen sharply in particular relative to their equivalent duration German bunds. The ECB will be very keen to avoid a repercussion of the sovereign debt crisis seen between 2011 and 2015.
What has emerged this week is that major central banks around the world are now firmly honed in on combatting higher inflation. They were, it could be argued, more focussed on not collapsing economic growth and creating a stagflationary environment. With inflationary pressures continuing to run hot, however, the market has almost forced a re-think.
This shift in stance however has certainly heightened volatility within investment markets. The S&P 500 entered a bear market from its January high this week, with concerns that a deeper economic slowdown could be damaging to corporate profitability, currently standing at very high levels. This had a knock-on effect across global equity indices in general. In the US meanwhile, the increased expectations for interest rates, coupled with growth concerns, has meant that areas of the US Treasury yield curve have inverted, or are very close too, yet again. The US 10-year, the 2-year spread is almost negative whilst it is negative looking at the 30-year, 5-year spread.
Corrections and the re-pricing of markets is a common phenomena, as investors react to the news around them. Periods of volatility can lead to periods of doubt, but also periods of opportunity. To summarise this week we refer to a quote from Peter Bernstein, “Prices change when events are different from what the market has expected them to be.”
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