28th March 2023
The Fed pivots its plan
Mike Tyson may have been better known for his boxing prowess than his life wisdom, but he certainly made a good point when he said: “Everyone has a plan until they get punched in the face.”
Last week, the US Federal Reserve was duly obliged to abandon its original plan due to the recent banking turmoil. In the volatile week following Fed Chair Jay Powell’s congressional testimony, interest rate expectations had shifted from a 0.5%-point hike to only a 50/50 chance of a 0.25% rise.
On Tuesday, Powell confirmed a quarter-point increase and stated that the Fed had curtailed its tightening scheme due to the banking crises. He also hinted that the resultant tightening of credit conditions was tantamount to one or more rate hikes. At 4.75%-5%, the key interest rate is at its highest level since 2007.
Notably, the Fed toned down its previous message that “ongoing” increases would be needed, saying instead that, “Some additional policy firming may be appropriate.”
Keith Wade of Schroders observed:
“The banking crisis is a sign that tighter policy is biting and, in our view, will tame inflation once the lagged effects have been allowed to come through.”
Wade noted that although the central bank and the markets share the expectation of another hike in May, their predictions differ beyond that point. The Fed committee projects a steady rate through 2024, while the market anticipates a 0.5% reduction by year-end.
Investor fears over the banking crisis eased in the early part of the week in the aftermath of the rescue deal for Credit Suisse and reassurance from central banks around the world about the security of their respective banking sectors.
Jonathan Harris of Schroders commented:
“Bank businesses are much more conservative, capital is multiple times higher than it was in 2008, liquidity is closely regulated, and central banks are in a much better place to respond given their experiences since 2008.”
The BoE follows suit
News broke on Tuesday that UK inflation had unexpectedly jumped to 10.4% in the year to February, up from 10.1% in January. Food prices increased at the fastest rate in 45 years, with the shortage of salad and vegetables a significant factor.
The inflation news only added to expectations that the Bank of England (BoE) would raise interest rates again, which it did. Thursday’s announcement of a further 0.25% increase, taking the base rate up to 4.25%, was the eleventh time rates have been put up since December 2021.
BoE Governor Andrew Bailey said he was more optimistic that the UK can avoid recession. The Bank said it now expects slight growth in the second quarter of the year having anticipated last month it would decline by 0.4%. However, Bailey cautioned against businesses raising prices, warning that if inflation were to become entrenched, interest rates would need to rise even further. He added:
“If all prices try to beat inflation, we will get higher inflation.”
Retail fights back
At the end of the week, the Office for National Statistics (ONS) released a report showing a stronger-than-anticipated increase in retail sales for February. Although sales volumes have returned to pre-pandemic levels, they remain 3.5% lower than the previous year. Discount and second-hand stores drove sales growth, highlighting the financial pressure on consumers.
The brisk start to the year by major economies was also indicated by an unexpected acceleration in business activity in the eurozone in March. Consumer spending on services played a significant role in this growth, raising hopes that the region can avoid a recession and allowing the European Central Bank to continue its tightening policy.
Similarly, in the US, a survey conducted by S&P revealed that both the manufacturing and services sectors experienced a surge in business activity in March. This marks the first time since September that new orders have increased across the board, suggesting a positive trend for overall business growth.
Investor nerves derail Deutsche Bank
Despite these signs of economic resilience, European banking stocks took another pummelling on Friday as Deutsche Bank found itself the next victim of investor nervousness. German Chancellor Olaf Scholtz sought to shore up confidence in the country’s biggest bank after its shares fell as much as 14%. Analysts agreed with Scholtz’s assessment that Deutsche is not the next Credit Suisse. “We view this as an irrational market,” observed Andrew Coombs of Citigroup.
The S&P 500 ended another volatile week in marginal positive territory, as did key UK and European indices. Following a risk-on tone at the start of the year, stock market leadership has shifted to more defensive and growth sectors like healthcare and consumer staples over the last month, highlighting again the importance of a diversified portfolio strategy.