Weekly View - Unsettled
Last week’s 50 bps Fed rate hike was not a surprise. Indeed, Fed chairman Jerome Powell’s assertion that a 75 bps hike had not been actively considered was enough to spark a stock rally. But it proved short-lived, with markets quickly returning to their fears about inflation. With the US labour market remaining tight and with inflation running well ahead of wage growth (the consumer price index rose an annual 8.5% in March, a four-decades high, compared with a 5.5% rise in average hourly earnings in April), markets may not be fully assured we won’t have a wage-price spiral, even as US credit growth continues to surge and consumers are still sitting on cash accumulated during the pandemic. With markets preferring the inflation threat to be tackled swiftly, they have been doing the Fed’s job by squeezing bond yields higher, hurting growth stocks in particular.
Last week saw other central banks continue to scramble to deal with persistent inflation. The Central Bank of Brazil and the Bank of England raised policy rates, as did (more unexpectedly) the Australian Reserve Bank and the Reserve Bank of India. The Bank of England’s (BoE) 25 bp rate hike came with some gloomy comments about the path ahead. The Bank thinks inflation could peak at an annual rate of over 10% only in October and also sees the UK economy contracting later this year. Just as in eastern Europe (although the Russian president Vladimir Putin did not use his Victory Day speech to officially declare war on Ukraine), the geopolitical temperature is rising on Europe’s western fringe. After the rise of the Scottish National Party, the nationalist Sinn Féin’s triumph in the Northern Ireland election could feed speculation about the breakup of the UK. What about the European Central Bank (ECB)? Some of its policymakers have made it clear that deposit rate could start to rise in July. Some countries are more vulnerable to rate rises than others, with Italian spreads hitting 200 bps last week. How the ECB manages to help countries facing higher funding costs will be an important test of its credibility, especially as it is scheduled to reduce its net purchases of government bonds. Yet the ECB may want to move fast to avoid raising rates in a declining economic environment later in the year. In the meantime, we remain underweight European government bonds.
All in all, volatility remains high on equity and bond markets alike. And yet; despite all the market anxiety, Q1 earnings reports have been decent. And while market conditions have become more challenging, discerning investors are still making liquidity available for some initiatives. Fitting in neatly with our sustainability theme, a high-profile climate fund last week raised USD7.5 bn.