By Jan Faure
Global markets declined in September after the US Federal Reserve (Fed) adopted a more hawkish stance towards its monetary policy outlook. While the Fed kept interest rates steady at its September meeting as expected, they conveyed their expectation that monetary policy would remain tighter throughout 2024. This contrasted with both market consensus and the Fed’s own June projections, which had suggested the possibility for 100 basis points of rate cuts next year. The revised Fed projections now indicate a more modest rate decrease of only 50 basis points in 2024.
The Fed’s adoption of a more hawkish stance had a significant impact on global bond and equity markets, prompting an adjustment to the realisation that interest rates will remain elevated for longer than previously anticipated. In the US, the S&P 500 declined 4.9%, while the tech-heavy NASDAQ Composite dropped 5.8%. In Europe, the Euro Stoxx 50 index declined 2.8%, while the UK’s FTSE 100 rose 2.3%, benefiting from both a weaker pound and a high concentration of energy companies on the bourse. Across Asia, Japan’s Nikkei 225 declined 2.3% while Hong Kong’s Hang Seng fell 3.1%. There was a notable increase in market volatility, driven by concerns over interest rate policy.
Notably, the yield on the US 10-year Treasury topped 4.6% for the first time since 2007, reflecting the combined challenges of large US fiscal deficits and persistent inflation, exacerbated by the Fed’s hawkish stance. Furthermore, 1-year Treasuries reached their highest yields since 2000. With the US labour market showing resilience and US economic growth remaining surprisingly robust, the Fed can afford to maintain a restrictive monetary policy stance until inflation returns to its targeted levels of 2%.
The European Central Bank (ECB) implemented its 10th consecutive interest rate hike, raising interest rates by 25 basis points to reach 4%. However, the ECB’s accompanying statement strongly suggests that this could be the last hike in the current cycle, as it believes that rates have reached a sufficiently restrictive level. Some of the more dovish ECB members pointed to signs of weaker economic growth, slowing bank lending, a cooling labour market and declining inflation to argue for a pause. The ECB anticipates that inflation will approach its 2% target in 2025.
The Fed’s hawkish stance weakened the soft-landing narrative that has increasingly become the consensus view. These concerns have been compounded by the recent surge in energy prices, which has slowed the decline in headline inflation. Brent crude surged 28% in the third quarter as OPEC+ leaders Saudi Arabia and Russia curbed production while the demand outlook improved.
If higher oil prices persist, central banks may face challenges should headline inflation begin to accelerate again. For now, energy remains an essential component of the modern global economy, with secular trends supporting growing demand and rising investment in alternative energy technologies and infrastructure.
Above target inflation is expected to keep interest rate policy elevated well into next year, despite inflation continuing to recede. The opportunity, therefore, lies with short-term interest rates that have risen more than intermediate and long-term rates through this cycle. This is a rare opportunity as 2-year US Treasury yields have only been above 10-year US Treasury yields less than 9% of the time since 1992. The resulting inverted yield curve thus presents investors with a unique opportunity to earn higher yields on short-term bonds, which are traditionally lower risk.
Table 1: Global Indicators – Local reporting currencies
