On Wednesday 4th May, the Federal Reserve in America moved to dampen high rates of inflation, announcing a sharp rise in interest rates by 0.5%, to a target range of 0.75% and 1.00%. This follows a 0.25% increase in March 2022.
These are the first rate increases since December 2018 and whilst we will no doubt look back in the medium term and agree these are needed to return to some form of economic ‘normality’ (whatever that may be!), right now they symbolise a big (and largely unwelcome) shift in policy, given the low base from which they arise.
Investment markets have been very nervous in the run up to this stage of the economic cycle and what we are seeing now is a form of tantrum at the prospect of tightening. In effect, the markets feel as though the increases are unhelpful and will hinder the prospect of global economic growth – given that nine of the world’s central banks raised interest rates in the same week.
As always, Becketts tries to take a more balanced and medium-term view, largely choosing to monitor, but not react, to short-termism. We acknowledge that central bankers have an unenviable task of both stopping inflation becoming the wage/price (or ‘cost/push’) spiral seen in the 1970s and balancing the prospect of negative economic growth (also known as recession). Right now, we would deduce they see eliminating the prospect of an inflation spiral as the more pressing need. Some would call this ‘policy error’, but we appreciate that the situation is more nuanced than that.
On the back of the rate rise, the Fed also announced that they recognise the impact on economic growth and moved to assuage fears by forecasting that steeper hikes were not under consideration.
Immediately following the announcement, a strong relief rally came about, the S&P500 recorded a daily rise of 2.98%. However the day after, with no further information – just a reconsideration of the same message – the index fell back by 3.58%, highlighting the confusion that currently abounds market sentiment.
In this environment of volatility, making short-term, knee-jerk reactions are just as likely to produce detriment as they are benefit.
The added combination of bond yield volatility, dented consumer confidence, continued supply chain and labour market strain as well as the likelihood of future higher energy prices (not to mention Russia/Ukraine conflict) all help to explain the downward pressure and sentiment.
Balancing this off, however, wary institutional investors have been avoiding capital markets for weeks and cash balances are building. With volatility high, there is incentive to remain on the sidelines for cash holders, but this won’t be the case for too long. We look forward to stabilisation (that will come) and the beginning of a likely steady upwards climb – albeit with expected sharp squeezes along the way.
We picked up an article at the end of last week highlighting a large cash ‘buying-the-dip’ play by a famously-successful US investor, which we believe adds credibility to this expectation.
Becketts’ mantra of common sense, diversification and unit-risk justification remain true today. In addition, our overlay of robust financial planning and cash management gives us the comfort of longer term focus. It is harder to focus on the longer term when the short term is just so noisy – but never has it been truer that patience rewards the committed, long-term investor.