David Dowsett, Global Head of Investments at GAM Investments, comments on the fed’s policy on inflation.
“Three-month, six-month and one-year annualised core Personal Consumption Expenditures are in the range of 4.7% to 5.1% following recent data out of the US. This is evidence that the initial easy reduction in inflation, which occurred between September and the end of 2022, was what drove markets and allowed terminal rates to remain constant in terms of market pricing.
“Now the more difficult work of reducing inflation to meet the US Federal Reserve’s target is beginning to confront markets, we believe several factors mean inflation is likely to be sticky. To some degree markets recognise this. Terminal rates for Federal funds during the market rally were fairly constant, oscillating between 4.75% and 5.1%. However, since the beginning of February, we have seen the rate breakout to 5.4%.
“We have also seen two-year yields reach new highs in the US and Europe. However, we do not think this is likely to result in a very dramatic capitulation of risk, a big sell-off or a return to the market conditions experienced last year. This is because the quantum of change we are thinking about here in terms of Federal funds is 0.5%, rather than the 4.5% correction we saw in 2022.
“In short, this may lead to choppy markets and a degree of correction after the recent very dramatic risk rally we have seen. However, it is unlikely to be so severe that we are required to go into full defensive mode. There is some speculation that the Federal Reserve will reaccelerate and implement a 0.5% hike at its next meeting. We think this is unlikely on the basis of what we see in markets at present. Rather, we believe we are witnessing an elongation of the rates cycle.”
