Equity markets were lower this week, as Federal Reserve (Fed) Chairman Jerome Powell indicated that in the face of strong economic data and stickier inflation, the committee were considering if higher interest rates than previously forecast might be required. “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Powell said in a statement released ahead of meetings this week on Capitol Hill.
The majority of stocks were lower on the news, bond prices fell (as yields rose), and the dollar rallied against most major currencies. Having previously indicated a 0.25% interest rate increase, expectations in the market now imply the strong possibility of a 0.5% increase when the Federal Open Market Committee next meets on the 21st-22nd March.
Higher interest rates than previously expected in the short run will not be welcomed by the majority of investors. The alternative, though, of being too loose now and seeing inflation start to trend higher again is not a risk the Fed want to take. If inflation started to rise again, this would cause them to pull the proverbial handbrake and increase interest rates higher and for longer than would have been required if they had stayed the course in the first place.
In the UK, we still expect inflation to fall back as we head towards the summer months. Going from 10% to 6% inflation is, however, likely to be a lot easier than moving from 6% to 2%. With the labour market still very tight, wage inflation looks likely to continue which makes getting towards the Bank of England’s target difficult without causing a sharp reduction in economic growth.
John Naylor, Chartered FCSI – Head of Investment Committee