A wrap-up in the weekly markets from Federated Hermes
Geir Lode, Head of Global Equities
Markets have been volatile this week as concerns around a potential recession and inflation continue to dominate the news. The Federal Reserve’s approach to managing these issues is being watched like a hawk, with investors wondering how heavy their foot will be on the gas pedal to avoid a downturn. 2-year yields hit highs not seen in over a decade, as 10-year yields stagnated and for the first time in four decades markets saw a full percentage point discount. It’s clear that the Fed’s decisions will have a significant impact on markets in the near future, however their disclosures have been limited in detail. Fed Chair Jerome Powell’s recent statement that no firm decisions on rates has been made and cited labour reports, which remain elevated, and inflation data as key drivers for policy decisions. These indicators will be key in determining whether the Fed can maintain their golden 2% inflation number.
While uncertainty remains high and the inverted yield curve indicating a potential recession is on the horizon, a diversified investment approach will be vital in navigating these markets.
James Rutherford, Head of European Equities
Over the past year we have seen a large number of companies reporting strong revenues and orderbooks but weaker margins. Multi-decade high inflation across Europe has supported revenues but put pressure on margins as corporates face higher costs. With demand weakening we expect pressure on corporate revenues to increase at a time when inflation is still persistently above central bank targets. As a result we expect profit margins to decline, something that has often been the prelude to a recession. In such a scenario we believe our portfolio holdings are well positioned given their ability to grow regardless of economic conditions due to their exposure to structurally growing markets and have strong pricing power, allowing them to defend their margins.
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Orla Garvey, Senior Fixed Income Portfolio Manager
Powell’s hawkish testimony to the Senate Banking Committee this week proved to be another big market mover in the context of the consistent stream of upside data surprises so far in 2023. Focus was on his comments around the potential for a higher terminal rate and a faster pace of hiking should the data warrant it; effectively confirming that the Fed would be revising their dot plot higher at the next meeting as expected. Rates markets repriced Fed dates accordingly such that we are now at a terminal rate of 5.6% in June this year, with roughly 25bps of cuts remaining in the curve.
More interesting than the move in nominal rates were the moves in inflation markets – TIPS real yields took the brunt of the repricing, with breakeven close to 25bps lower in the belly of the curve. Inflation markets have proved a good guide for the direction of nominal and risk markets this year; this type of price action is indicative of rates markets moving to price overtightening and should be a negative signal for risk markets. The March FOMC (22nd) is priced at 42bps, so with the Fed on blackout from this weekend focus remains on data. Surprises either way to Non farms and CPI next week have potential to be market moving given current. We do expect that break-evens remain under pressure with downside surprises signalling the potential for overtightening and stronger data forcing the Fed to remain hawkish.
Moreover, in Europe: Post last week’s strong HICP data euro terminals rates have continued to move higher and now sit at 4% for the end of 2023. Euro linkers in contrast to TIPS have taken this move higher in their stride; the entire euro inflation curve now sits above the TIPS curve; this is highly unlikely to be realised over time. The market is basically telling us that the Eurozone will now run inflation higher than the US and that the economy will be absolutely fine with CB rate at 4-4.50% – we are sceptical on this; and yet we could easily see ECB terminal rates continue to converge on the BoE/Fed or the market start to price a faster pace of ECB rate hikes if the data stays strong.
Silvia Dall’Angelo, Senior Economist
During his recent semi-annual testimony to Congress, the Federal Reserve’s Chair Powell provided hawkish remarks on the short-term trajectory of monetary policy. He suggested that the strength of economic data justifies a higher terminal rate, emboldening market expectations of an upward revision to the Fed’s dot plot at the upcoming March meeting. Short-term rates markets now expect a peak rate of 5.6% in Q3 2023, compared to 5.1% in the Fed’s December forecasts. The JOLTS report on Wednesday also indicated significant tightness in the US labor market. Job openings eased only slightly in January, leaving the vacancies-to-unemployment ratio at an historically high 1.9.
In contrast, European Central Bank (ECB) officials have publicly disagreed over the pace and extent of tightening going forward. Some members have urged for more aggressive action in light of concerning developments in inflation, while others have stressed declining headline inflation and risks to economic growth. Despite recent downgrades in euro zone Q4 GDP, high consumer and wage inflation will dominate the ECB’s thinking for now a 50bp rate hike is a done deal for March, and more might follow. Eventually, the ECB trajectory will be driven by the evolution in the growth-inflation trade-off – indeed, ECB’s chief economist Lane stressed data-dependency.
China’s ongoing National Party’s Congress has also been in focus, with authorities surprising markets by setting a lower-than-expected growth target of 5% for 2023. This may be an attempt to temper expectations regarding fiscal and monetary stimulus, as Chinese policymakers seem unwilling to take significant action due to risks to financial stability and awareness of lower marginal returns of additional traditional stimulus. The emphasis in China is now on domestic demand and self-reliance, which likely implies more limited spill-overs for global growth. However, the situation remains volatile, and data-dependency is challenging, particularly given the somewhat distorted data. As such, it remains to be seen how the global economy will fare in the coming months, and whether the Fed and ECB will stick to more hawkish more hawkish rhetoric and actions to combat inflation.
