The Federal Reserve (The FED) in America is responsible for keeping interest rates and inflation under control and sticking to a targeted national employment level.
Earlier this month, we saw a whipsaw in markets as FED chairman Jerome Powell gave his monthly speech concerning policy direction and the opinion of the FED and its members.
Global Markets rose 1% within the first few minutes of the speech only to fall to negative 2% by the end of the address. This perfectly encapsulates the market’s opinion surrounding monetary policy in America – as interest rates rise and the FED being at the top of the list of concerns for investors globally.
This price action in the market was primarily due to the speech starting off positively with a potential pause in rate hikes being speculated. This was later rebutted by Powell who stated “there was a lot more work to be done” and it was “too early to think about pausing”.
OCTOBER INFLATION LEVELS
Fundamentally, this meant that the inflation figures for October were the most important piece of data moving forward. An inflation figure at or below consensus would decrease the likelihood that the FED would increase their aggressive rate hikes.
On the 10th of November, the October inflation levels were released with CPI being 7.7% from a year-on-year perspective. This was 0.3% below the 8.0% consensus.
This came as welcome news to both stock and bond markets with strong rallies across the board. It also means the market is predicting a lower likelihood of steep rate hikes from the FED over the next few months as it may imply that inflation has peaked.
The S&P 500, a major US index, rallied over 5% and the NASDAQ 100, filled mostly with tech, rose 7.4%. Bond indices also rose on the news, although less than the stock markets.
UK mid and smaller companies rose substantially as well as European indices.
WHAT DOES THIS MEAN FOR THE FINANCIAL MARKETS?
We can’t be sure that we are through the worst of it, and interest rates and inflation are still at historically high levels. What we can be happy with is the positive reaction to improving news – as it shows that once the issues are less prominent, a strong recovery is there in waiting.
We have echoed throughout every update that knowing the issues we are facing is the first step in rectifying them. Interest rate rises are slowing the economy, tightening consumption and putting a strain on expenditure – but they appear to be slowing inflation.
Over the long-term, inflation can be a runaway train – causing much more damage than painful rate hikes and this is why it’s imperative that it’s controlled.
TIME IN THE MARKET VS TIMING THE MARKET
As ever, the notion that “time in the market rather than timing the market” is at the front of our minds. A better-than-expected inflation figure was exactly that… unexpected. Remaining invested during volatile times does mean you have to sit tight through the bad days, but it also means you are invested during the leaps up in recovery.
Over the long-term – the issues we are facing at the moment will feel like a blip along the upward trend.
HOW DOES RISING INTEREST RATES AFFECT INFLATION?
As interest rates rise, it makes it more and more expensive for people to borrow money and instead encourages people to spend less. As a result, spending less on goods and services results in prices slowly rising. The faster prices rise, the faster levels of inflation rise.
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