By Jan Faure
Hawkish pivot by the Fed roils markets
Global markets declined as a hawkish turn by the US Federal Reserve to fight inflation stoked intense market volatility. Technology stocks bore the brunt of the sell-off due to their valuations being heavily weighted towards future earnings, thus making them highly sensitive to interest rate changes (especially unprofitable growth stocks). The tech-heavy Nasdaq Composite index sank 9% in January. A disappointing start to the US corporate earnings season and growing concern over Russia's troop build-up on Ukraine's border also dragged on sentiment. The S&P 500 index declined by 5.3%, saved in part by the surging energy sector (+19%). Energy was the only sector to finish in positive territory on the S&P 500 in January.
Fed Chairman Jerome Powell said the central bank is preparing to raise interest rates in March as part of its effort to fight the highest inflation in decades. This came as December’s CPI reading of 7.0% was the highest since 1982 and well above the Fed’s target of 2%. Persistent supply chain disruptions, high energy prices, and wage pressures have killed any hopes that inflation would be transitory. Powell was less certain on when the Fed will begin to reduce its large balance sheet (quantitative tightening). As one of the tools to fight the pandemic, the Fed bought trillions of dollars of securities to support the economy and financial markets.
US Consumer Price Index: running above 2%target for 10 months
The key concern following the Fed meeting was the unclear message on its monetary policy tightening plans. There is debate on how aggressive the Fed will be with interest rate increases, with some economists predicting five rate hikes this year. Fed officials continue to believe inflation will slow and reverse later in the year as base effects kick in and as supply and demand imbalances improve.
The Bank of England raised interest rates in December for the first time in three years after inflation reached its highest level in 10years. A major factor driving inflation in the UK and Europe has been rising gas prices. For its part, the European Central Bank is sticking to its guns and refraining from raising rates despite inflation having reached 5%, the highest on record for the Euro area. The ECB is of the view that inflation will drop below the 2% target level in the fourth quarter.
Brent crude oil surpassed $90 per barrel in the final days of January, its highest level since October 2014. Tight global supplies and geopolitical tensions in Eastern Europe and the Middle East helped brent crude close out the month at $91.21 a barrel, a gain of 17.3% for the month. OPEC and its allies, known as OPEC+, have moderated supply increases since the pandemic decimated demand. This policy has increasingly led to supply shortages. Adding to pressure on energy prices has been the deployment of thousands of Russian troops to the Ukraine border. Russia is the world’s second-largest oil producer, while 30% of Europe’s energy needs stem from Russia.
Markets have started the year on the back foot on fears that excessive monetary tightening could derail the gains made from pandemic-induced stimulus measures. While uncertainty holds over the Fed’s plans for monetary policy this year, we expect market volatility to continue. As we’ve seen in the past, monetary policy will be guided to a large extent by data. The IMF has flagged slower global growth this year (4.4% down from 4.9% predicted previously) which has the potential to stem inflation. The factors causing inflation are however varied and sticky, meaning overcoming them will take time. Policy makers have shown themselves to be sensitive to markets and won’t want to see any major fall-out from tighter policy. As such, the year will be a challenging balancing act.
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