The week ending 22 April saw a nasty slide by US stocks into the close of the week.Triggering the sell-off was, in our view, a distinct racheting-up of hawkish rhetoric from policymakers. For example, on 21 April, after Fed Chair Jerome Powell emphasised the virtues of 'front-loading' rate rises in a speech (his last before going into purdah ahead of the meeting of the Federal Open Market Committee on 3-4 May), expectations for tightening moved sharply higher.
Market pricing suggests that the market now expects a full extra percentage point increase in thefed funds rate from the next two FOMC meetings. By next February, the rate — still stuck at zero at the beginning of 2022 — could, if the market is right, reach 3%. Our fixed income team expects US policy rates to rise even higher, to 3.25-3.50%.
As shown in the chart of the week, the anticipation of aggressive monetary policy to counter persistently higher inflation has led to a significant rise in real yields. This in turns weighs on stock valuations. Rising interest rates mean the value of future cash flows fall as they are discounted to present value. Higher interest rates typically mean future cash flows are more heavily discounted by investors lowering the worth, particularly of growth stocks which are valued on longer-term horizons.
This pattern of rising interest rates compressing stock valuations was what we saw early this year prior to the start of the conflict in Ukraine. Previously, the strength of earnings led a turnaround. Corporates delivering on earnings growth is key to supporting returns at the beginning of this rapid Fed tightening cycle. Earnings so far this quarter have been better than expected, but markets will be sensitive to downgrades in corporate outlooks.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
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