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Higher (US Interest Rates) For Longer!

Inflation, and therefore the associated movement in interest rates, remains the key driver for markets as it has all year. Higher interest rates are bad news for both stocks and bonds. For stocks, principally because they slow the economy down and raise the cost of corporate borrowing. For bonds, because bonds prices and yields/interest rates have an inverse relationship i.e., bond yields /interests rates up equals bond prices down.

Inflation has been slowly falling in the Western world all year, but it is also proving stubborn with wage growth, supply problems and higher energy (oil and gas) costs.

The Central Bank response to higher inflation has over the past 18 months has been one of the sharpest rises in interest rates ever with rates moving from broadly zero per cent (in a response to Covid) to just over 5% in the US and UK (4 % in Europe). 

The big question is – Is inflation under control and falling back to more normal 2-3% levels and therefore is the Central Bank interest rate rising cycle over?

The week of Sept 16th we had 3 crucial Central Bank meetings/interest rate decisions.

1) The US Central Bank – the Federal Reserve – decided to hold its benchmark ‘Fed Funds Rate’ at a 22-year high at 5.25%-5.50% (Fed Funds – the interest rate at which banks borrow and lend reserves to each other on an overnight basis – trades in a quarter point range and influences all other US interest rates)

The market expects one more 0.25% interest rate rise before a slow fall over the next 18/24 months. But from the Federal Reserve’s comments at the meeting, policymakers are hardening their commitment to “higher (interest rates) for longer”.

2) The ECB – European Central Bank – raised its benchmark deposit rate by a quarter of a percentage point to an all-time high of 4 per cent, up from a record low of minus 0.5% last year. Investors hope the ECB has finished raising interest rates.

3) The Bank of England also kept interest rates unchanged at 5.25% after UK inflation fell from an annual rate of 6.8 per cent in July to 6.7 per cent in August – surprising economists who had been expecting a small rise.   

So, with such Central Bank deliberation, investors are hoping that we are at the top of the interest rate rising cycle which provides hope for stock and bond prices but at the same time the Central Banks are warning they will not hesitate to raise rates further should inflation not fall as is hoped by this high interest rate regime.

With Oil at $90 a barrel – relatively high looking at the last few months and a firm price due to OPEC and Russia restricting supply to keep that price up, global markets will continue to be dominated by the inflation news.