Rising inflation that prompted the Fed to suggest faster tapering which may accelerate rate hikes has rattled markets.
The much-watched US Consumer Price Index (CPI) rose by 6.2% on an annualized basis, its highest level since 1990. Higher energy and food prices were principally blamed, though the index still rose by 4.6% when these factors were stripped out.
This caused the US Federal Reserve to change its view on inflation from a ‘transitory’ phenomenon to something more permanent during a 30 November testimony by Chairman Jerome Powell to the US Congress, catching markets by surprise.
Equities dropped on fears that a much faster unwinding of stimulus programs (tapering) to combat inflation would be followed by the earlier introduction of the first rate rises since they were cut in March 2020 to combat the pandemic. Bond market gains on the new omicron Covid strain were reversed as they started to price in an earlier rise in rates, now seen in May 2022.
“Bond markets globally are faced with rising inflationary pressures and the Fed has now moved away from this ‘transitory’ narrative, which opens the window for faster tapering,” says Peter van der Welle, strategist with the Robeco multi-asset team.
“The Fed funds futures curve steepened in reaction with market participants bringing rate hikes forward in time, with the May 2022 FOMC meeting now seen a ‘live’ (rate-setting) meeting.”
“Based on the swaps curve, rate hike expectations seem to be peaking at around the 1.75% level (up from the current 0.25%). This implies a relatively low terminal rate compared to previous hiking cycles, which is having a gravitational pull on the yields of US 10-year Treasury bonds.”
Equities were already reeling from the announcement of the more contagious omicron variant of Covid-19 which prompted flight bans and more containment measures in Europe, particularly hurting travel and hospitality stocks.
That was still being absorbed when Powell commented that the Fed should “consider wrapping up the taper of our purchases perhaps a few months sooner”, given that “at this point the economy is very strong and inflation pressures are high”.
“November is typically a fairly good trading month for equity markets, on average adding 1% to year-to-date returns,” says Van der Welle. “Not so this time around, with global equities dropping 1.5% in the month. The sting in the tail was provided by Powell’s Congressional testimony which caught analysts by surprise.”
“This is a hawkish pivot away from the ‘inflation is transitory’ mantra. At this juncture the Fed is accentuating the hawkish overtones as it has grown more uncomfortable with inflation. The level and speed of inflation increases the risk of second-round effects and entrenched inflation.”
“The nature of inflation matters. Current inflation is not predominantly of the ‘good’ type – the non-accelerating type that coincides with an economy that is operating in equilibrium. Instead, the global economy is experiencing bad inflation caused by supply constraints which ultimately could pave the way for ‘ugly’ inflation.”
“Given the ongoing strength in the US labor market, the potential for this kind of ugly inflation that stems from a wage-price spiral is increasing on the back of improved negotiation power of labor versus employers.”
Van der Welle says Powell acknowledged that the Fed had misjudged inflation as demand was artificially supressed by the pandemic while supply-side pressures created non-linear effects that escaped the normal macro models.
“The new omicron Covid strain adds further momentum to Powell’s latest twist,” he says. “The OECD has warned that inflation will only abate once the pandemic is over. A new strain could lengthen the battle against Covid and thereby inflation.”
But it’s not all bad news, following a stellar US third-quarter earnings season that shows companies are still gaining pricing power, which bodes well for equities.
“We continue to think that the end of tapering does not mean a seamless transition into a rate hike cycle, as the Fed ideally would see a higher participation rate before raising the policy rate,” says Van der Welle.
“We expect inflation to moderate in 2022 and this provides the Fed with some leeway to assess whether part of the decline in the participation rate is cyclical. Ultimately, it is not so much the policy rate lift-off date that matters for equity markets, but the degree of tightening versus the terminal rate.”
“With the probability of an over-tightening Fed low in the near term, the US economy will be able to absorb the first policy rate hikes and will continue to grow at a healthy pace in 2022.”
“Meanwhile, flare-ups in infections and the discovery of new Covid variants may trigger temporary risk-off phases that will be beneficial for government bonds.”
The information contained on these pages is for marketing purposes and solely intended for Qualified Investors in accordance with the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”) domiciled in Switzerland, Professional Clients in accordance with Annex II of the Markets in Financial Instruments Directive II (“MiFID II”) domiciled in the European Union und European Economic Area with a license to distribute / promote financial instruments in such capacity or herewith requesting respective information on products and services in their capacity as Professional Clients.
The Funds are domiciled in Luxembourg and The Netherlands. ACOLIN Fund Services AG, postal address: Affolternstrasse 56, 8050 Zürich, acts as the Swiss representative of the Fund(s). UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zurich, postal address: Europastrasse 2, P.O. Box, CH-8152 Opfikon, acts as the Swiss paying agent. The prospectus, the Key Investor Information Documents (KIIDs), the articles of association, the annual and semi-annual reports of the Fund(s) may be obtained, on simple request and free of charge, at the office of the Swiss representative ACOLIN Fund Services AG. The prospectuses are also available via the website www.robeco.ch. Some funds about which information is shown on these pages may fall outside the scope of the Swiss Collective Investment Schemes Act of 26 June 2006 (“CISA”) and therefore do not (need to) have a license from or registration with the Swiss Financial Market Supervisory Authority (FINMA).
Some funds about which information is shown on this website may not be available in your domicile country. Please check the registration status in your respective domicile country. To view the RobecoSwitzerland Ltd. products that are registered/available in your country, please go to the respective Fund Selector, which can be found on this website and select your country of domicile.
Neither information nor any opinion expressed on this website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco Switzerland Ltd. product should only be made after reading the related legal documents such as management regulations, prospectuses, annual and semi-annual reports.