Market Overview – 14/04/2022

Once again interest rates and prospective action by central banks was front and centre of market attention last week. Minutes from the last US Fed meeting showed that agreement had been reached on a programme to reduce the Fed balance sheet i.e., reversing the accumulation of bonds purchased through the Quantitative Easing initiative over the last two years. Although no starting date was given, it is expected that this process will begin in May. The irony of this is that even as recently as March, the Fed was still purchasing $30 billion of bonds a month despite talking about the need to tighten monetary policy for the previous three. The possibility of one or more 50 bp rate increases was also discussed. Markets are now expecting US interest rates to reach 2.5% by the end of this year, a level the central bank deems to be a “neutral rate.” Minutes from the European Central Bank’s last meeting, although not as hawkish as its US counterpart, showed increasing anxiety about the rising pressures of inflation and what the appropriate policy response should be. The ECB is still in bond buying mode, but it was agreed that this should end in Q3 this year. It is widely anticipated that interest rates will start to rise in the Eurozone shortly thereafter.

There is much speculation about whether recession is inevitable as a result of interest rates going up. The decision to increase borrowing costs is in response to higher levels of inflation. In turn, higher inflation is a result of supply constraints prompted by Covid-19 restrictions and lockdowns (something central banks can do nothing about) and excess demand, which is a function of the high levels of fiscal and monetary stimulus introduced to alleviate the dislocations caused by Covid-19. The latter is something that central banks feel they can do something about. In particular, the US economy is running hot, with full employment and above trend GDP growth. Central banks do not have a great track record in “engineering” soft landings, but there is a growing determination among them to stop inflation becoming embedded in the system. At the end of the day, higher prices and the resultant pressures on disposable incomes should of itself reduce demand. Hopefully central banks will pick up on this quickly enough to avoid the dreaded “policy error.” 

This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it.