The Fed threatens to reaccelerate rate increases if inflation persists, sending markets southwards
It has been a volatile week for equities and bonds ahead of the latest employment data due out of the US later today. Earlier in the week Jerome Powell, chair of the US Federal Reserve (Fed) said they would be prepared to reaccelerate the pace of interest rate increases if the economy and inflation failed to cool. US Treasuries sold off with the yield on the 10-year US Treasury touching 4.01%, having been as low as 3.34% earlier in February, whilst 2-year Treasury yields exceeded 5% for the first time since 2007. The inversion of treasury yields, whereby shorter dated Treasury yields exceed those of longer dated bonds, and considered a harbinger to an impending recession, increased to over 1%. Banks, which hold large reserves of bonds on their balance sheets, were hit particularly badly, as rising bond yields reduce the value of those bonds. The canary in the coal mine appeared as a small US bank, Silicon Valley Bank, announcing a share sale to reinforce its capital base. The US non-farm payrolls employment data is due out later today, with forecasts of 225,000 new jobs to have been created in February. However, January’s forecast of 189,000 new jobs was blown wide apart with 517,000 new jobs having been created, making investors particularly jittery ahead of today’s figures being released.
As of 12pm on Friday, London time, US equities fell 3.2% over the week, with US technology stocks falling by 3.0%. European stocks were down by 2.0% and UK equities dropped by 2.6%. Despite falling sharply at the end of the week, the Japanese market managed to hold onto gains of 0.6%, whilst Australian stocks fell by 1.9%. Emerging markets dropped by 2.0% with China being a large contributor, with domestic ‘A’ shares falling by 3.0% and offshore Hong Kong stocks dropping by 6.1%. Bullishness in the Chinese equity market has cooled in recent weeks as the rhetoric between itself and the US has escalated, whilst following the relaxation of covid restrictions, China has also not attempted to boost their economic recovery through monetary loosening, instead relying on Chinese consumers to do the heavy lifting.
German and UK government bond yields followed those of the US, rising earlier in the week before bonds rallied towards the end of the week as a wave of risk aversion swept over markets. 10-year German bunds are currently trading at a yield of 2.53% and gilts 3.70%.
Gold dropped by 0.8%, now trading at $1,840 an ounce, whilst the risk of rising bond yields reducing global demand, led to crude oil falling by over 5%, with Brent crude now trading at $80.9 a barrel and US WTI (West Texas Intermediate) $75.0.
Issues under discussion
Despite US interest rates rising sharply, so far inflation, excluding energy prices, has proven to be sticky, with the jobs market remaining very strong. Consequently, the Fed is feeling the pressure to get inflation under control. However, whilst it is known that monetary policy acts with a lag, judging this is definitely more of an art than a science. With bond yields having returned to levels not seen in a decade, investors are at least getting paid to hold defensive assets should the Fed raise rates too far and tip the US into a recession.