Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
A year ago, at the annual central bankers’ summit, Jackson Hole, the US Federal Reserve’s key view was that inflation was “transitory”. This year’s summit couldn’t be more different, a summary can be found in Powell’s words: “Restoring price stability will likely require maintaining a restrictive policy stance for some time”.
This was a clear attempt to kill the market’s belief that the Fed was performing a dovish pivot. The markets have consistently had a bias for anticipating a Fed pivot towards more dovish policy, despite comments from Fed members. History explains some of this prejudice.
Since Fed Chair Greenspan in the 1980s, markets have had what they want: steady growth and low inflation. Reduced economic volatility provided reduced uncertainty and, along with quite a lot of Fed liquidity, asset markets generally benefited materially.
Fast forward to today and the Fed is up against it. Not only is the economic environment very different, but the Fed needs to improve credibility, as forecasts and communications have been poor. Clearly the broader message is a less positive one: companies are facing higher borrowing costs, higher input costs and volume pressures. Similarly, consumers are facing higher borrowing costs and a higher cost of living.
The Fed would prefer to keep inflation under control without pushing asset markets lower, but in practice they seem to appreciate that it is not now possible, as financial conditions need to tighten. How high interest rates have to go, and how long for, is essentially guess work, especially in Europe where the energy shock is so pronounced. Furthermore, that governments will attempt to alleviate the cost of living crisis only adds to the uncertainty, in terms of fiscal policy. Economic volatility and policy risk are elevated, and so is uncertainty.
The Fed will continue to emphasise their data dependency but many investors will continue to believe, in their hearts of hearts, that the Fed will come riding to the rescue if financial conditions tighten too much, even with the quantitative tightening drum beating louder and louder. At the same time, if the Fed continues to lack credibility, they will have to raise more than they otherwise would. Furthermore, if they lose too much credibility, the pressure on their political independence will increase.
What does a more hawkish Fed mean for markets? In equity, growth would likely continue to underperform value, and bonds would continue to struggle, having already erased much of their June and July rebound. The US dollar would likely continue outperforming and it would be mixed for commodities, with likely tight supply but end demand slowing.
We continue to believe that markets are too optimistic and underappreciate the degree of genuine guesswork involved in understanding the profile of interest rate moves from here. As a result, we remain cautious.
