Markets Trim Fed Rate Hike Expectations

Fed Rate Hike

A review of the week’s top global economic and capital markets news.

As of noon on Friday, global equities are on track to snap a seven-week losing streak as investors anticipate that the US Federal Reserve will not need to tighten as aggressively as feared to bring inflation down. The yield on the benchmark US 10-year note declined to 2.74% from 2.81% a week ago while the price of a barrel of West Texas Intermediate crude oil gained $1.50,  to $113.70. Volatility, as measured by the Cboe Volatility Index (VIX), declined to 27 from 29.4.

MACRO NEWS

Markets adjust US rate expectations
Investors are pricing in fewer rate hikes from the Fed in the coming year than they were a few weeks ago. At the moment, markets see the federal funds target reaching a terminal rate of just below 3%, down from about 3.5% little more than a week ago. Weakening US economic data, such as a sharp decline in new home sales and softer purchasing managers’ and regional Fed surveys, suggest the central bank will need to tighten less than previously feared. Q1 gross domestic product was revised lower on Thursday, to an annualized -1.5% from an earlier -1.3% estimate. The Fed’s preferred inflation measure, the core personal consumption expenditures price index, edged down to 4.9% year over year in April from 5.2% in March, it was reported on Friday. The combination of a somewhat-more-hawkish European Central Bank and lowered Fed expectations prompted a pullback in the dollar versus other major currencies this week.

 

ECB plans to hike rates to at least 0% by end of Q3
In a blog post this week, European Central Bank President Christine Lagarde signaled an end to the ECB’s asset purchase program early in Q3, allowing the central bank to hike rates from the current level of -0.5% at its July meeting. Based on the current outlook, Lagarde sees the ECB as being in a position to exit negative interest rates by the end of Q3. Lagarde said that given the highly uncertain current economic backdrop, the central bank will adjust policy gradually, maintaining optionality and flexibility. In the wake of the post, market pricing suggests about 0.85% of tightening before the end of the year. However, in contrast with the Fed, ECB officials indicated this week that the central bank is unlikely to begin shrinking its balance sheet any time soon for fear of destabilizing financial markets in countries such as Italy and Greece.

 

US partners with 12 Asian nations
US President Joe Biden this week traveled to Asia, where he unveiled the Indo-Pacific Economic Framework. Though not a trade or security pact, the framework is meant to strengthen relations among countries in the region. It envisions the region’s economies becoming more connected, more resilient, cleaner and fairer. US aid to less-developed signatories is expected to be part of the framework. Large countries such as India, Japan, Indonesia and Malaysia are represented, as are smaller ones such as Thailand, Vietnam and Brunei.

 

CBO expects slower growth, lower inflation
The US Congressional Budget Office projected this week that both inflation and growth will cool later this year and into 2023. The CBO expects a 3.1% growth rate in 2022, down from the 5.5% rate in 2021, and sees the economy growing 2.2% next year. It forecasts that inflation will fall to 4.7% in late 2022 and to 2.7% in 2023, while unemployment is expected to remain close to 50-year lows. Reduced federal pandemic aid should see the government’s budget deficit decline to around $1 trillion this year from $2.8 trillion in fiscal 2021.

QUICK HITS

Partially funded by a windfall profits tax on energy companies, the British government this week proposed a 10 billion support package to help families with soaring energy costs. The program is aimed primarily at the country’s poorest households and pensioners. The proposal comes amid a cost-of- living crisis in which the real incomes of Britons are being squeezed by a surge in inflation and a sharp decline in economic sentiment.

 

Seasonal demand for gasoline in the United States is at its lowest level since 2013 (except for 2020) as the summer driving season gets underway, Bloomberg reported. With prices roughly 50% higher than a year ago, demand is about 5% lower. 

 

Awash in tax receipts and federal pandemic stimulus, state and local governments are in excellent financial condition and are well-positioned to withstand a potential US economic slowdown, MFS municipal bond analysts say.

 

The Bank of Korea raised rates 0.25% to 1.75%, its third increase this year. The Reserve Bank of New Zealand hiked rates another 50 basis points. 

 

After warnings from the US Securities and Exchange Commission, SPACs restated their financial statements at a remarkable rate last year. Restatements rose 289% from 2020 levels.

 

China’s Premier, Li Keqiang, told public officials this week that the country’s economy is “to some degree worse” than it was at the start of the pandemic in early 2020 and called on companies to rapidly reopen. Li’s comments reinforce the idea that China will fall well short of its 5.5% economic growth target in 2022 amid continued conformance with President Xi Jinping’s zero-COVID policy. As the country struggles to reopen the economy while controlling the spread of the coronavirus, generating headlines, the two leaders are apparently being pitted against one another.

 

There has been a significant loss of momentum in the US housing market in recent months. The latest data showed the pace of new homes sales slowed dramatically in April, falling 16.6%, the biggest drop since 2013 though prices continued to soar, with the median price up 19.6% from a year ago. The supply of existing homes continues to jump, according to Realtor.com. Listings rose 9% compared with the same period a year ago as sellers try to take advantage of higher prices.

 

In a speech outlining US policy on China, Secretary of State Anthony Blinken said Thursday that Beijing is becoming more repressive at home and more assertive abroad and that it remains the most serious threat to international order.

 

US births increased in 2021 for the first time since 2014, to 3.66 million. That’s up 1% from 2020, the National Center for Health Statistics reported this week. However, at 1.66, the US fertility rate remains well below the replacement rate of 2.1.

 

As part of its twice-yearly financial stability review, the ECB this week warned that unbacked cryptoassets represent a risk to financial stability. Leverage and lending activity in the crypto market has become more risky, complex and interconnected with traditional financial institutions, the ECB cautioned.

 

A US Securities and Exchange Commission official said on Tuesday that significant issues remain in reaching a deal with China over auditing compliance of China-based companies listed on US exchanges.

 

Stay focused and diversified
In any market environment, we strongly believe that investors should stay diversified across a variety of asset classes. By working closely with your investment professional, you can help ensure that your portfolio is properly diversified and that your financial plan supports your long-term goals, time horizon and tolerance for risk. Diversification does not guarantee a profit or protect against loss.

 

The information included above as well as individual companies and/or securities mentioned should not be construed as investment advice, a recommendation to buy or sell or an indication of trading intent on behalf of any MFS product.

 

Securities discussed may or may not be holdings in any of the MFS funds. For a complete list of holdings for any MFS portfolio, please see the most recent annual, semiannual or quarterly report. Full holdings are also available on the individual Fund Summary tab in the Products section of mfs.com.

 

The views expressed in this article are those of MFS and are subject to change at any time. No forecasts can be guaranteed.

 

Past performance is no guarantee of future results.

Sources: MFS research, Wall Street Journal, Financial Times, Reuters, Bloomberg News, FactSet Research, CNBC.com.

 

This content is directed at investment professionals only.  

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