As markets brace for a “no landing” world where economic expansion remains solid, and inflation rises steadily, investors are less certain about buying both risk assets and government debt. For months now, they have gambled on the global economy weakening to the extent that would subdue rising prices and motivate hawkish Fed and other central banks to hold off from interest rate hikes.
Fed’s Efforts to Lower Inflation by Slowing the Economy May Have Failed
After the idea of the Fed and other central banks applying monetary tightening to guide a gentle descent before transforming direction to avoid an extreme downturn emerged in October, it encouraged capital allocations across assets, made the dollar weaker, and spurred investments into emerging economies. Yet lately, data depicting enduring tight labor markets have caused traders to consider another possibility where economic progress stays healthy while inflation remains constant.
That implies that yields may also climb, which is a detriment for risky investments. On Wednesday, world stocks dropped to their lowest levels in one month, and Wall Street had its most terrible day of the year so far on Tuesday.
“We’ve gone from softer landing to no landing – no landing being that (financing) conditions will remain tight,” stated David Katimbo-Mugwanya, head of fixed income at EdenTree Asset Management.
In January, U.S job growth surged while U.S and German inflation remained elevated; in February, both American and European business activity saw a comeback. Consequently, investors have discarded their outlook for interest rate cuts later this year and swapped them for forecasts of higher rates that are now estimated to reach 5.3% by July – an increase from the 4.8% recorded in early February- whereas Deutsche Bank has suggested that European Central Bank rates will peak at 3.75%, up from its earlier projection of 3.25%.
If the Fed Continues to Raise Interest Rates, Undesirable Consequences Could Happen
Richard Dias, the founder of Acorn Macro Consulting, noted that China’s reopening and Europe’s attenuation in the gas crisis and a robust U.S. consumer expenditure are “more bearish than positive for markets.” According to him, “we’re entering into an environment where good news is bad news.” In agreement with this observation, Paul Flood – head of mixed assets at Newton Investment Management – voiced his concern about a potential further rise in interest rates if wage growth and demand remain high, which could be detrimental to both equity and bond markets.
As expectations of greater returns on money rise, bond prices decline, and yields surge. This usually causes stock markets to move lower to compensate for the heightened risk of owning shares. Currently, U.S 10-year Treasury yields have soared close to 4%, which marks an increase from early January’s 3.3%. Meanwhile, a dollar index indicating its performance against other chief currencies is set for its first monthly rise in five months as interest rate hike forecasts thrust the greenback upward.
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