Financial Markets are still be driven by the inflation demon and the Central Bank response to raise interest rates aggressively. US inflation (although rising inflation is a global phenomenon) is running at an annual rate of 8.3 per cent compared to a Central Bank target of 2 per cent.
At the next FOMC (Federal Open Markets Committee) meeting on September 20/21 the markets are expecting an unprecedented third, consecutive 0.75% percentage point rise in the ‘Fed Funds Rate’. The Fed’s current target range for this key rate, ahead of rate rises next week, is 2.25 to 2.50 per cent.
Higher interest rates are of course bad news for stocks as it
– slows the economy down and reduces corporate profitability
– increases the cost of corporate borrowing
– makes bonds a more attractive investment
Stocks are also volatile at the moment, hanging on the release of every economic and inflationary data release. The main US S&P 500 index is down around 15% for the year and the more interest rate sensitive NASDAQ (technology) index down 20% as such stocks pay very little dividends.
In a sign traders are expecting more aggressive Fed action (raising interest rates) US Government (and global bond prices) have been under pressure all year i.e. rising yields. The yield on the US two-year note is 3.85% yield-to-maturity and the yield on the 10-year is 3.45% – the highest for a number of years.
The US Dollar index is up about 13% this year, propelled higher by higher interest rate rises and hawkish (‘tough’) messaging from the US Central Bank (Federal Reserve) about the future path of monetary policy.
The US Dollar has historically been seen as a haven asset during times of economic stress with dollar strength fuelled further by the interest differentials between the US and other countries i.e. the higher US interest rates, the more investors are going to be wanting to take advantage of those interest rates and hold dollar assets.
Subsequently other currencies are struggling…
GBP: Sterling has slid to its lowest level since 1985 against the dollar after a round of weaker than expected data on UK retail sales amplified concerns that the country was headed for a prolonged recession. The pound dropped as much as 1 per cent today to $1.135, the first time it has breached the $1.14 mark in almost four decades, before recovering to about $1.142 in the New York trading day.
EURO: Trading weakly and close to parity (1 EUR = 1 USD) although the European Central Bank last week lifted interest rates by 0.75 %, and pointed at further rate rises to come. This is providing some EUR support.
JPY: With the Japanese Central Bank following a looser monetary policy, the Japanese Yen is trading at its weakest for 24 years with $1 = JPY 143.
OIL is caught between two headwinds: On the one hand, the war in Ukraine and behaviour of Russia – a major oil exporter – is forcing up the price of a barrel of oil, at one stage taking oil to $140 per barrel. But global recession fears (and hence a lower demand for the oil) has brought the price back down to just over $90 per barrel.
GOLD: Is trading at $1,700 per ounce well below its $2,050 all-time-high reached during the Covid crisis. Although gold should perform well as hedge against inflation, gold is a non-interest-bearing asset and with bond yields rising, the latter becomes a more attractive investment asset i.e. Sell gold, Buy bonds.