Stock markets have continued to rally over the last couple of weeks, further buoyed by the Federal Reserve Bank's recent monetary policy statement. Throughout 2022, rate hikes were in the order of 0.5 and even 0.75 basis points. The most recent one, however, was only 0.25 basis points. A number of traders, investors and pundits have inferred from this that the US central bank's aggressive monetary tightening programme is coming to an end.
Fed chair Jerome Powell, however, has been quick to warn investors that the assumption that the central bank is considering halting or even cutting rates any time soon is quite wrong. Indeed, following last week’s announcement, the federal funds rate now stands at 4.50% to 4.75%. It is expected that rates will be increased by a similar percentage at the next meeting of the Federal Open Market Committee in March.
On this side of the Atlantic, the European and UK central banks have raised their interest rates to their highest levels since before the Global Financial Crisis. ECB President Christine Lagarde has pledged to stay the course and raise interest rates at a steady pace in a bid to return inflation to its 2% target rate. This will likely mean a further 0.50 basis point hike next month.
Bank of England Governor Andrew Bailey has warned that while inflation may have begun to fall, measures need to be implemented to ensure that the current trend continues. It is now thought that this year’s recession will be milder than initially forecast and that further rate rises will only be necessary if inflation proves too stubborn.
Andrew Bailey’s statement had an immediate effect. The 10-year gilt yield slipped to 3.17%; sterling, meanwhile, weakened against both the euro and the US dollar. Notably, the Bank of England made no real attempt to suggest that the financial markets were in any way misguided in expecting interest rate cuts later this year. That said, the Monetary Policy Committee members did warn that the risks to inflation are skewed significantly to the upside. Generally, the actions of the world's three leading global banks seem to have coaxed traders and investors into a buying frenzy, targeting both equities and bonds.
Later last week, however, any expectations of a significantly lower US employment rate report were dispelled. The US economy added a whopping 517,000 new jobs in January – more than double the consensus forecast. Other parts of the economy may be showing signs of slowing, but the healthier labour market should help bolster consumer spending. This in turn should help to moderate any potential downturn.
The Federal Reserve Bank will doubtless have some concerns over the continuing tightness of the US jobs market. It will have hoped that the recent aggressive interest rate hikes will have been enough to “cool” the jobs market. Manifestly, this has not happened.
Both global equity and bonds have risen significantly in recent months, and October 2022 now looks very much like the bottom of this current bear market trend. After 2022, during which bad news came thick and fast for investors, this year has so far been the polar opposite.
But have financial markets risen too quickly? Will some of these gains end up being relatively short-lived? The answer is almost certainly yes. But in all likelihood, inflation has peaked, interest rate hikes are nearing an end, corporate earnings remain robust… and although the labour market is tight, things should ease over the coming months.
We do not believe that the financial markets are going to test those October lows any time soon. Admittedly, some weaknesses may still return to the stock markets, but we think that this is an excellent buying opportunity for both equities and bonds. Indeed, the case for investing in fixed-income is highly compelling – it offers the balanced investor healthy prospects for increasing their bond exposure with confidence.
Last year, the traditional portfolio – underpinned by a “60:40” strategy involving a split between stocks and bonds – registered its worst combined total return performance since 1872. Long-term investors should never waste a crisis: they should take advantage this year of what happened last year.
Inflation is still elevated, and although the price of oil is some 40% lower than last year's peak, food prices remain high. It is entirely possible that inflation will fall further before rising again and remaining stubbornly high for some time, as it did in the 1970s. It is also possible that the Federal Reserve Bank will “overcook” the economy with its aggressive monetary policy and raise interest rates too much. This could ultimately slow down the economy and create a hard landing, rather than the soft landing it is currently striving for.
As we move into spring, we should remember that the markets are by no means immune to further bad news. The bear market may have receded (yielding to a potential new bull phase), but a dramatic reversal of fortunes is still possible – as we saw in 2020 and 2022.
The US market is up by some 16% since mid-October. International markets have fared even better: they have risen 28% from their late 2022 lows. And this rally has not been confined to just equities – bonds have gained around 9% since mid-October, benefiting from the fall in interest rates. This sharp rally in an extremely short period may prove troublesome. Any further bad news may run the risk of triggering another downturn. We do, however, believe that the foundations for a new bull market and a period of economic growth are slowly being laid. Cautious optimism remains our mantra as spring swings into view and we start looking towards the end of this first quarter.
