No more Mr Nice Guy

After a turbulent start to the year, US Stocks and bond prices dropped even lower on Wednesday afternoon after the chair of the Federal Reserve (Fed), Jay Powell, made it clear that the first increase to US interest rates since 2018 will be implemented at the Fed’s next meeting in March.  During the month of December, the annual pace of US consumer price inflation reached 7%. Powell had always said that if inflation got out of control, the Fed would be willing to bring in heavy weapons to knock prices down.

Last month, the Fed’s policymakers released projections that implied there would be three interest rate rises in 2022. In just one month this projection has been revised up, with potentially five rate rises this year now on the cards! In fairness, Jay Powell refused to rule out a more aggressive approach during 2022, adding that there was space to tighten monetary policy without harming the labour market.

In response to the hawkish speech from Powell on Wednesday, global equity markets went into risk-off mode. Having rallied ahead of the meeting, the S&P 500 closed marginally lower on the day, the US yield curve flattened and the Volatility Index spiked to its highest level since February 2021.

As Covid appears to be shifting towards a more endemic existence and supply chain bottlenecks look to be easing globally, we may well see inflation moderate. However, with US President Biden warning Ukraine of a possible invasion next month, escalating tensions at the Russia-Ukraine border could put pressure on already high commodity prices and keep inflation well above the Fed’s target.

As shown in the above chart, world equity markets are significantly lower today than they were at the beginning of the year and the familiar spectres of inflation, interest rates and Covid are likely to keep investors honest, with pockets of heightened volatility in the short term at least.

We believe portfolios are well equipped for this transitional period. They have avoided a significant part of the recent equity drawdowns due to positions in alternative assets (e.g., property, hedge funds, commodities) which are designed to diversify returns and help protect in times of stress, as well as significant exposure to the UK and more cyclical firms, which have outperformed on a relative basis. We continue to assess the markets and look to identify entry points for attractive opportunities, which can often present themselves during periods of volatility.

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