21 June 2022
US rate hikes
With growing apprehension around an impending recession, and central banks continuing to raise interest rates, global equities posted some of their worst returns last week since the outbreak of the pandemic.
The US Federal Reserve made its biggest move since 1994, increasing rates by 0.75%. Unlikely to be the last of the hikes, the Fed forewarned that it “anticipates that ongoing increases in the target range will be appropriate.”
This came about just a few days after the official revelation that US inflation had hit a four-decade high of 8.6% – way above the Fed’s 2% target.
The enormity of this rise was felt throughout financial markets, with investors increasingly concerned about a potential recession. Not only that, but the S&P 500 plunged by -5.8% – its poorest weekly performance since the first half of 2020.
This week will see markets watch with anticipation when Fed Chairman Jerome Powell testifies to the upper and lower chambers of Congress.
Elsewhere on markets
Interest rate rises were likewise seen elsewhere, with the Swiss National Bank making a surprise move with its first rate increase since 2007. This opening Swiss salvo was a 0.5% increase, and it advised of further potential increases in the future.
The Bank of England (BoE) raised rates by 0.25% – for its fifth consecutive meeting. Given the Fed’s acceleration, questions are now being posed about whether the BoE might follow in its footsteps and start to increase the rate by larger amounts.
AXA’s Adegbembo Modupe commented:
“We see a 0.5% move in August as firmly on the table, but for now continue to expect 0.25% increases in August, September, and November as our base case.”
There could be a number of influences at play – commodity and energy markets are unstable and are set to remain so as long as the war in Ukraine continues. Recent weeks have shown that this, in turn, will impact on inflation, and the ongoing inflation expectations will themselves have an effect. On the other hand, Modupe called out the labour market as being critical to the BoE’s assessment of medium-term inflation pressures, and remains tight.
“Signs of further labour market tightening would likely steer the Committee towards a sharper move next month – particularly if wage growth continues at the high monthly rate posted in April. For now, we remain of the view that Bank Rate will rise to 2.0% by November and will close the year at this level – far short of current market expectations.”
Striking a balance
Over the course of the week, both the FTSE 100 and 250 dropped sharply – by -4.1% and -3.8%, respectively. In a similar vein across Europe, the MSCI Europe ex. UK declined by -4.5%.
The problem that central banks now face is attempting to equalise the need for growth with attempts to control inflation. Indeed, increasing interest rates helps to reduce inflation, yet this can also hamper economic growth by making it more expensive to borrow. Due to the fact that growth is already struggling, many fear that an abrupt increase rate rise could push economies into a recession.
The debate around increasing rate rises will likely continue to directly affect investor returns.
Alexander Robinson, Associate – Global Assets at leading investment consultancy Redington, proposes:
“At the moment, Central appear to have embarked on a rapid tightening of monetary conditions, with interest rate hikes accompanying balance sheet reduction (otherwise known as Quantitative Tightening). If they hold to this path, it seems unlikely that equity markets can move meaningfully higher unless valuations become much more attractive. If inflation does, belatedly, prove somewhat transitory and economies are starting to weaken, then it is likely that central banks will need to change tack, and in turn this would be more positive for equity markets.”