Euphoria over lower headline inflation, as commodity prices have fallen and supply chains have improved, had contributed to the dovish stance taken by the market prior to the speech. However, these factors alone will not be enough to get inflation down to the Fed’s target. Domestically-driven inflation from services, and higher rents emanating from a tight labour market, are still huge problems. What’s more, economic data have started to re-accelerate, with the fall in gasoline prices spurring a rise in real incomes, reigniting the market’s expectations of higher inflation in the future. A divergence between soft data (opinion surveys) and hard data (collected facts) has been building in recent months, with the soft data notably weaker than the actual economic outcomes. In a ‘cost’ crisis, it makes sense that vicious falls in consumer and business sentiment might paint a worse picture than reality: economic actors may complain a lot but in the end they tough it out. Economic data have surprised to the upside recently, although this has not been getting much airtime as it is not in line with the current ‘crisis’ narrative. In any case, the cascade of fiscal support happening everywhere should shift the balance towards the hard data signal being the one to follow.
The Federal Reserve is rightly focused on the tight labour market, and a universal effort is underway by Fed speakers to remove the interest rate cuts priced by the market into 2023 and beyond. This is likely a Fed that will get rates up and keep them there, reacting asymmetrically to economic developments by keeping more tightening on the table and not taking the risk of cutting any time soon. Powell’s speech cited the case of the 1970s, when the Fed chased its own tail, cutting prematurely on economic weakness, which lead to inflation oscillating out of control as the economy went through a boom-and-bust cycle. Things are different today, but there are some similarities, as labour and capital become less globally mobile. He also threatened the market that the Fed ‘dot plot’ of individual Fed views on the path of policy rates will be updated at its September meeting. A case for less 2022-front loading and more use of the yield curve to tighten financial conditions is being made by the Fed here. Most clearly though, all this points to a higher terminal rate in the US being priced into markets.
China remains a risk for the global economy, with its housing market and constant lockdowns a deadweight. However, the commodity price declines this has supported is helping growth and inflation profiles in the global economy, as it eases the pressure on resources. What’s clear is that the link between a weaker China and global interest rates of the pre-Covid years has broken down with the rise of inflation pressures. A sharp decline in the Chinese yuan would likely halt the global yield sell off; however, the Chinese authorities are acting to steady the decline in their currency. Monetary easing and stimulus efforts have been ratcheted up in recent weeks, but likely more needs to be done to support growth, especially regarding the housing market.
Overall, the market’s pricing in of an easing in US financial conditions, as bonds and equities rallied in recent months, looks unjustified. There’s little question that the Fed is going to be tough. The outcome for markets now hinges on whether it will a soft or hard landing for the economy, to achieve the necessary fall in inflation. A soft landing would require labour supply to return and job openings to fall without causing too many job losses to help wage gains ease back. This path would likely mean risk assets have already found the bottom and would add support for under-priced cyclical assets. If wages stay high, much higher yields and lower equities will be required, creating more recessionary conditions. On the day, Powell’s message was received loud and clear by the markets, as equities fell sharply and bond yields rose. In summary, we see ‘higher for longer’ interest rates and ‘stronger for longer’ economic outcomes as key themes during the rest of 2022.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Get in touch
The views expressed are those of the author at the time of writing, are not necessarily those of Jupiter and may change in the future. This is particularly true during periods of rapidly changing market circumstances.
This document is intended for investment professionals* and is not for the use or benefit of other persons, including retail investors, except in Hong Kong. This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued in the UK by Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited (JAM HK) and has not been reviewed by the Securities and Futures Commission. No part of this document may be reproduced in any manner without the prior permission of JAM/JAMI/JAM HK. 28855
*In Hong Kong, investment professionals refer to Professional Investors as defined under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).and in Singapore, Institutional Investors as defined under Section 304 of the Securities and Futures Act, Chapter 289 of Singapore.