Please see today’s daily market update from Brooks Macdonald below:
What has happened
Against the backdrop of the last few weeks of volatility, yesterday can be described as a much needed, orderly trading session. The release of the Federal Reserve minutes did little to upset this state of calm with US equities extending their gains after the publication.
Federal Reserve minutes
The Fed made it clear, in line with recent communications, that they were willing to front-end load monetary tightening in order to fight inflationary pressures. The minutes also endorsed the use of 50bp rate hikes at the next few meetings in order to do this. There were some more dovish overtones within the statement however, with Fed staff saying that financial ‘conditions had tightened by historically large amounts since the beginning of the year.’ Officials were also concerned about the impact of quantitative tightening on liquidity and potential ‘unanticipated effects on financial market conditions.’ The bond market interpreted these doubts around market stability as the Fed acknowledging the tricker economic backdrop and therefore becoming less likely to aggressively tighten policy. Pricing for 2022 rate rises fell back further which means that around one full 2022 25bp rate hike has been discounted since the start of the month. This repricing helped buoy US technology shares which outperformed the broader index.
Inflation and the ECB
As economic growth fears have increased, investors have dialled back their inflation expectations, expecting poorer demand to take the edge off higher inflation risks. In Germany, 10 year inflation breakevens, a measure of expected average inflation over the next 10 years, fell to 2.23%, not far from the ECB’s target and a far cry from the near 3% reading at the start of May. In Europe there are arguably two forces at play, the aforementioned global growth fears but also a growing expectation that the ECB will exit its negative interest rate policy in the short term. Vice President de Guindos of the ECB endorsed the comments made by President Lagarde in her recent blog post, saying that the rate hike schedule was ‘very sensible’ given inflationary pressures.
What does Brooks Macdonald think
The bond market has priced in a softening of Fed monetary policy in recent weeks, wagering that the central bank will blink in the face of growth fears. The coming weeks of central bank speak and indeed the next meeting statement, will be vitally important to test whether the Fed’s inflation fervour has been dented by the recent misses in economic data.
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Andrew Lloyd DipPFS
26/05/2022