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Weekly investment update – Markets in a sea of uncertainty

At its first policy meeting of 2022, Chair Jerome Powell of the US Federal Reserve signalled that the central bank would begin boosting interest rates…



This article was originally published by BNP Paribas Asset Managment Blog ( Investor's Corner)

At its first policy
meeting of 2022, Chair Jerome Powell of the US Federal Reserve signalled that
the central bank would begin boosting interest rates from their crisis-era lows
in March. To get the inflation genie back into the bottle, our fixed income team
expected the Fed to have to raise rates faster and further than what was by
markets. Chair Powell’s latest comments support that view.

Markets have already had to digest a lot of information this
year on the two main drivers of asset returns: discount rates and cash flows.
Among the issues are increasingly hawkish central banks, led by the US Fed,
uncertainty over the outlook for policy and growth generated by Omicron and
escalating tensions with Russia over Ukraine.

The question is now whether markets can continue to climb
the wall of worries.

In the week ending 21 January, we saw mixed market sentiment
manifested in a struggle between the urge to ‘buy-on-the-dip’ and an impulse to
sell based on concerns that an aggressive Fed policy would drive up yields.
Indeed, the sharp rise in US (real interest rates has been the number one
reason pushing US stock indices lower since the New Year.

Equity markets have shifted abruptly as a result. The
S&P 500 index has lost about 10% of its value so far in January, with
growth stocks hit particularly hard.

Nothing illustrates the troubled market sentiment better
than the huge swing in US stock prices on 24 January with the Dow Jones
Industrials index closing up by almost 100 points, or 0.3%, after falling by
more than 1 100 points early in that trading session. The tech-heavy NASDAQ
Composite closed the day 0.6% higher after initially dropping by almost 5%.
This volatility was repeated on 25 January with the Dow recouping most of its
819-point loss to end the day down a modest 68 points.

Catch-up moves could see Fed hike seven times

In the immediate wake of the Fed’s latest policy meeting,
stock markets fell sharply across Europe and Asia after Chair Powell signalled
the central bank would begin raising rates in two months’ time. Highly valued
tech stocks bore the brunt of the selling in Europe and Asia.

Some in the markets now believe the Fed is so far behind the
curve that it will raise policy rates by 50bp from March. We do not share that
view, but our fixed income team has a strong, out-of-consensus view, expecting
seven rate rises this year, whereas the market prices four to five rate

If our more hawkish view gains momentum, a faster pace of
Fed rate rises could weigh on market sentiment.

After the recent release of strong US inflation and labour market data (Exhibits 1 and 2), the rate policy-setting FOMC now appears to think the economy is approaching maximum employment and inflation will remain high instead of being transitory.

Chair Powell noted that the ‘economy is in a very different
place than it was’ at the onset of the last rate rising cycle: the economy is
on a stronger footing, the labour market is healthier and inflation is higher.

This comment was reiterated several times during the press
conference and, crucially, with the observation that “these differences are
likely to have important implications for the appropriate pace of policy

Indeed, the message from the meeting was significantly more
hawkish than the signals in the Fed’s December ‘dot plot’. That showed a clear
consensus across the FOMC on raising rates three times this year.

When asked about the possibility of raising rates in 50bp
increments, Chair Powell said no decisions had been made. That was not an
endorsement of the idea of a 50bp hike, but neither was it a denial.

Taking away the punch bowl

The FOMC confirmed that the Fed would shrink its massive balance
sheet significantly by ending the reinvestment of maturing securities – assets
which it bought in large volumes during the pandemic to support the US economy
– after it has begun raising rates.

Chair Powell signalled that the balance sheet run-off might
begin at the May or June FOMC meeting. Some market participants expect the Fed
to act more aggressively by cutting its existing asset purchases by USD 60
billion a month or more.

According to Statista 2022, the size of the Fed’s balance
sheet was USD 8.87 trillion on 18 January. Even if the Fed ran down its
holdings by USD 100 billion a month, its balance sheet would still be larger by
the end of 2024 than it was in January 2020 (USD 4.17 trillion) when the
pandemic started.

Any views expressed here
are those of the author as of the date of publication, are based on available
information, and are subject to change without notice. Individual portfolio
management teams may hold different views and may take different investment
decisions for different clients. The views expressed in this podcast do not in
any way constitute investment advice.

The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.

Investing in emerging
markets, or specialised or restricted sectors is likely to be subject to a
higher-than-average volatility due to a high degree of concentration, greater
uncertainty because less information is available, there is less liquidity or
due to greater sensitivity to changes in market conditions (social, political
and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.  

Writen by Chi Lo. The post Weekly investment update – Markets in a sea of uncertainty appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.

interest rates

central bank

Author: Chi Lo


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