9 November 2021
Against all odds
Last week saw global equity markets generally rise, as investors processed the US Federal Reserve’s plans to start tapering its economic support, while the Bank of England (BoE) unexpectedly decided not to raise rates.
It was anticipated that the BoE would raise interest rates at its regular Monetary Policy Committee (MPC) meeting on Thursday last week, due to ongoing inflation. These predictions only became more assured once BoE Governor Andrew Bailey said it would have to take action if inflation persisted.
Ultimately, however, the central bank contradicted expectations, voting 7–2 to keep interest rates at their record 0.1% low for the time-being.
On the whole, equity markets responded positively to the surprising news, with the FTSE 100 rising notably in the 24 hours following the announcement, before dropping slightly. It still managed to conclude the week up, as it shifted further into post-pandemic highs. Nonetheless, the news did see Sterling distinctly fall on Thursday.
As for bond traders, the news was not so straightforward. Despite the fact that lower interest rates are broadly better for bonds, it may have given a few traders who had bet on an increase in rates a few headaches.
Speaking on the ‘Making Sense of the Market’ podcast, Lauren Smith, Content Strategist at St. James’s Place, explained the following:
“This shows there is a gap in expectations between officials from central banks and traders, in terms of what they think interest rates are going to do, and this gap is increasing the chance of market volatility.
“The real takeaway for clients around this topic is, of course, the old truism of ‘time in’ not timing. But also, they really don’t want to be in that gap [in expectations] between officials and traders, because it is quite a volatile space.”
A well-diversified portfolio with exposure to different asset classes and different regions can help add some protection for investors when extraordinary events such as this take place, rather than simply gambling on when a rate change may happen.
Although rates were not raised in this instance, the BoE did note a rate rise may occur in the not-too-distant future:
“The Committee judges that, provided the incoming data, particularly on the labour market, are broadly in line with the central projections in the November [Monetary Policy] Report, it will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.”
The previous day, the Federal Open Market Committee (FOMC) in the US also voted not to raise interest rates – although this was expected. Nevertheless, it did announce it would start to cut back on some of its economic support measures implemented during the pandemic.
This included reducing its monthly net asset purchases by $10 billion per month, and agency mortgage-backed securities by $5 billion per month. On this basis, the bank will have completed its bond-buying exercise by mid-2022.
The US, like the UK, is experiencing high inflation. In recent months it has been drifting around the 5.3% to 5.4% mark. The Fed asserts that this is down to largely transitory events, such as supply and demand imbalances linked to the global economy reopening.
The move to begin tapering had been expected for some time, which might explain why markets reacted so calmly.
Indeed, following the BoE and the FOMC announcements, US markets were decidedly up. The S&P 500 rounded off the week 2% up compared to its position on Monday, as the US index shifted further into record territory. The Nasdaq rose by over 3% over the course of the week – again, moving further into that record territory.
Looking ahead, the FOMC did state that it was prepared to adjust its stance if risks emerged that might hinder the recovery. With COVID-19 still ever-present, as well as supply chain issues still not dealt with, this flexibility could well be in order.
David Page from AXA Investment Managers noted:
“The progress of wage growth in the US is likely to prove critical – something that Fed Chair Powell acknowledged was ‘key’. As such, we consider that risks of an earlier hike would increase if wage growth does not soften materially into the start of next year.”
In Europe, meanwhile, the STOXX Europe 600 continued its upward trajectory. The pan-European index has performed well since a drop in September – and it finished the week up over 7% compared to its low on 6 October, thanks to a better-than-expected earnings season.