The Federal Reserve this week announced a 50 basis points increase in its rate, the first hike of this magnitude in 20 years. This move did not come as a surprise at all and was in line with many analysts’ expectations and, indeed, with the Fed’s communications.
FOMC meetings are becoming a bigger event as central banks around the globe continue to tackle high inflation. What did come as a surprise, however, was the market’s reaction on the day of the rate hike announcement – the S&P 500 surged by an impressive 2.99% as the Fed signalled that sharper incremental rate hikes of 75 basis points were off the table. This upward move in the index was, however, short-lived as trading on Thursday saw these gains wiped out completely, posting a loss of 3.55% for the day. This illustrates the extraordinary levels of volatility currently present in markets.
This steep correction has been followed by a further negative movement of 0.5% on the S&P as at the time of writing, which has led to the broad US stock market experiencing its worst start to the year since 1939!
The big question now is whether Federal Reserve Chairman Jerome Powell can halt inflationary pressures with its plans to implement further hikes and a contraction of its balance sheet (termed as quantitative tightening) in an attempt to bring inflation under control to 2%, without plunging the economy into a recession. The latest US inflation figure was 8.5% year-on-year to March 2022.
While Powell has previously expressed confidence that the US economy is sufficiently robust to withstand the rate hike cycle, some analysts believe this cannot be achieved, thereby forecasting a recessionary environment for the US economy in 2023.
Rather than predicting economic outcomes in an uncertain and rapidly changing environment, we are focussing on inflation-proofing our clients’ portfolios which are constructed for optimal, risk-adjusted returns over the long-term. Our preferred asset class in attaining this objective remains global equity, as the yields offered by alternative asset classes such as cash and US treasuries are likely to remain well below the inflation trajectory, while the listed property sector is, in our view, likely to continue to face structural headwinds.
Although equity markets will undoubtedly remain both volatile and vulnerable in the short-term, companies that do not depend on leverage, have relatively high gross margins together with pricing power that enable them to grow their earnings irrespective of the economic environment, offer – in our view – a compelling investment case to combat the negative impacts of high inflation on our clients’ portfolios.
“The main goal of quantitative tightening is to normalise (i.e., raise) interest rates to avoid increasing inflation, by increasing the cost of accessing money and reducing demand for goods and services in the economy.”
– Wikipedia definition of quantitative tightening
Global News
- The US’s Federal Reserve has announced its biggest interest rate increase in more than two decades as it toughens its fight against fast rising prices. It lifted the interest rate by half a percentage point, to a range of 0.75% to 1%, after a smaller increase of 0.25% in March. With US inflation at a 40-year high, further hikes will undoubtedly take place.
- Noteworthy is that a measure of certainty has been signalled by the Federal Reserve, in that it is committed to bringing inflation down to around 2% over time and that a 50 basis points rate hike should be expected at each of the “next couple of FOMC meetings”. This would suggest that the decision-making process by the FOMC has become significantly less data dependent than normal – particularly for the next few months.
- Following this news, India’s central bank has announced a surprise increase to its benchmark rate, while Australia’s central bank recently enacted its first interest rate hike in more than a decade. The Bank of England raised rates by 0.25% on Thursday, the fourth increase since December 2021.
- In line with our “political polarisation” theme in last week’s news, additional sanctions are set to be levied against Russia as European Union chief executive Ursula von der Leyen has proposed a phased oil embargo on Russia, as well as sanctions on its top bank, and to ban Russian broadcasters from European airwaves. This could be a watershed for the world’s largest trading bloc, which is dependent on Russian energy and must find alternative supplies.
- Despite the challenging environment caused by Covid-19 lockdowns in China and the conflict in Europe, Volkswagen expects the protracted shortage of semiconductors to ease during the second half of 2022 leading to a surge in output and offsetting months of curtailments.
Local News
- The JSE had little in the way of directional moves offsetting gains and losses from previous trading days, instead experiencing back-to-back losses throughout the week across all major sectoral indices. The ALSI itself was down more than 6% for the week.
- The rand, in contrast, experienced a dual directional week. After trading at R16.08 to the US dollar on Monday, the currency strengthened by 3.92% to R15.46 on Wednesday (the day of the Fed’s rate hike announcement), but subsequently weakened to R15.96 on Friday to end the week relatively flat.
- Business Maverick has seen a document that summarises the consolidated demands of trade unions, which include a 10% wage increase applying to all public servants – regardless of their employment level or number of years in service. The magnitude of this increase would negatively impact both inflation and the country’s fiscal metrics.
- South Africa’s monthly petroleum product imports are expected to triple next year as domestic refineries close, according to energy consultant Citac. The same report says that while the country already relies on imports to meet up to 60% of its fuel demand, any increase in shipments will require improvements to existing storage facilities, ports, and pipelines. Next year’s clean-fuels policy is likely to result in the shutting down of refineries unable to meet the new standards, leaving only one-third of the country’s peak processing capacity operational.
- FirstRand Bank has raised more than R2 billion in funding for green and social investments by issuing its first sustainability bonds, which received strong demand from investors.
- South Africa is among the top ten countries to have experienced the most cybercrime in 2021. It ranked sixth, significantly lower than the UK which topped the overall cybercrime density list for the second consecutive year. South Africa had 52 victims per one million internet users, almost 92 times less than the UK.
- Finally, in regional news, Russia’s war against Ukraine is causing additional ripples, with Zimbabwe President Emmerson Mnangagwa trying to emulate Russian President Vladimir Putin in his attempt to revive Africa’s worst performing currency! According to Bloomberg sources, Mnangagwa’s administration may announce plans for Zimbabwe government departments to favour payments in Zim dollars. Zimbabwe is under US sanctions for economic mismanagement and human rights violations for the past two decades.
Sources: Dynasty, UBS, Bloomberg, BusinessLive, News24, Moneyweb, Reuters, BBC, etc.