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Was this the week that the US Federal Reserve (FED) blinked first? As expected, US interest rates rose by 0.75% for a second consecutive month and this by itself was not a surprise. What was interesting was the comments by the FED chairman Jerome Powell that the FED would move towards a more data dependent decision in September as to how much to raise rates, rather than their preferred forward guidance that has been used up until now. The FED are aware that core inflation has already started to slow with more sticky factors like wage growth and rent rises contributing to pushing the overall rate higher last month. At the end of the day, monetary policy has a delayed impact on inflation. It is rather like a footballer passing the ball, you want to pass the ball to where the striker is running to, not where they are currently. Data dependent monetary policy is similar, you want to adapt your monetary policy to where you think the data will be, not where it is today. These comments were viewed by market commentators as the first sign that whilst the FED will continue to raise rates, as will other developed market central banks, perhaps the size of these rate rises will start to fall as growth slows, inflation starts to slow and recessionary fears rise. It is early days, but the equity market, especially technology shares, have rallied strongly.
If Jerome Powell and his colleagues do want to get interest rates in the US to the range of 3.25% to 3.50%, then we are now only 1% away with three meetings left this year to raise rates. Therefore, it would seem unlikely that the next rate rise will also be 0.75%. The FED has also stated that it would like to double its current balance sheet (debt) reduction from $45bn a month to $90bn from October, and this would be very difficult if a recession was taking hold and all of these factors appear to be starting to weigh on the FED. In addition, sharply rising rates in the US have driven the US $ higher in 2022 and IBM have warned that the strong $ could reduce its revenues from onshoring foreign sales by $3.5bn this year.
The US has a distinct advantage over the UK and Europe in that most of its inflationary pressures are internal, whereas in Europe the Russia / Ukraine conflict has caused such an issue with energy prices that it is hard to see inflation slow and fall as quickly here. July inflation data in the US is expected to be well below the 1.3% monthly rise in June and the FED will have all this data to hand before it makes its next rate decision in September.
Clients in our favoured investment propositions will be aware that our managers started buying back into bond markets in recent months as interest rate rises have pushed bond yields up to a level where they now not only offer better value, they also offer a nice defensive characteristic to portfolios once again. This is explained by the inverse nature of bond yield movements to capital returns on bonds. If bond yields rise, bond capital values fall and vice versa. Therefore, you do not want a large exposure to bonds if you expect interest rates to push bond yields higher. At this point, if the bond market gets no worse, you can benefit from a 3% yield, however if market conditions deteriorate, interest rates are cut and bond yields fall and capital values of bonds go up. For every 1% fall in a 10-year bond yield, you will approximately make an 8% gain on your capital. Good portfolio protection in our eyes.
In further short term good news, reporting season is underway and whilst Tech giants like Apple and Amazon have reported a reduction in quarterly profits, they are not as bad as many had feared and sales of iPhones have remained relatively robust. All of a sudden, an 11% fall in Apple profits is seen as good news. Markets are starting to look through current data on the first two quarters of 2022 and are hoping for better times ahead.
Elsewhere, the pressures on consumers continue to rise, with 20% rise in prices common. McDonald’s 99p menu is moving to £1.19 and Amazon are increasing the annual Prime fee from £79 to £95 a year, the first price rise since 2014. Familiar brands like Dove Soap and Persil washing powder have risen by over 11% in the second quarter and a consumer shift to supermarket own brands is starting to hit big consumer brand names.
In the two weeks since I last wrote the markets have moved on, we have an interesting insight into central bank policy for the second half of the year, the UK political outlook looks even more of a mess and we once again have a football team competing in the European Championship finals. Good luck to the ladies, and we have our hopes high not just for the match against Germany, but also for a recovery in markets as we move on through the year. Do have a good weekend, and please do get in contact if you have any questions.
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