Rate Increases and Market Expectations

Michael Rudd, CFA | President, CEO and Portfolio Manager

Last week, we wrote about the US Consumer Price Index topping a 40-year high and coming in at 8.6% for the year. The real impact from the data was that broad prices (excluding the food & energy components) had increased month over month, indicating that general inflation was rising. Food and Energy comprise just over 21.5% of the index and they can skew the results higher or lower quite dramatically. The issue last week was that month-on-month change in broad inflation had increased. Expectations, on the other hand, were that the index would be flat or even decrease. This caused concern that the US Federal Open Market Committee (FOMC) would increase administered rates higher than what was expected and that potentially inflation was getting out of control.

  • We reprint Figure 1 again this week to present the increase in broad inflation that has obviously accelerated since the beginning of the year. One item to note was that this data was released just 5 days ahead of the FOMC meeting, which took place on Tuesday of this week.
  • Prior to the data being released, “the market” was expecting a 50-basis point raise from its current level of 1.0%. The market also expected that the administered rate would peak in the spring of 2023 at 3.0%. Just ahead of the meeting, markets were still expecting a 50-basis point increase, but the peak rate had increased to just under 4.0%. The FOMC did in fact raise interest rates more than expected, moving an aggressive 75-basis points higher. It was also indicated that they could do so again at the next meeting in July. The FOMC Chair also noted that this was the first time in his career that data received so close to the meeting had impacted the ultimate decision. At first, this was viewed favourably resulting in a strong close for North American equities, but markets subsequently reversed the next day reinforcing a new official “bear” (top to bottom drop of 20%) in most global markets.

“This means that”, as we wrote last week, we should expect more volatility from financial markets as both central banks and investors work through higher inflation expectations. Interestingly, the Bank of England took a more dovish approach with their rates and Japan was even more accommodative, basically refusing to raise their rates from -0.1%. China, on the other hand, is dealing with completely different issues given that they have very little inflation and an economy that is suffering from COVID mitigation measures. This diversity of approach and situation in various parts of the world is one element of the investment landscape that has changed dramatically.  It will create new risks, but also provide new opportunities.

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