Unpacking the latest rate increases from key central banks
On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and Client CIO Chris Kyle discussed recent interest – rate increases from key central banks. They also provided an update on investor sentiment.
With inflation still above target, are more rate hikes in store?
Kyle and Lin opened the conversation with a look at the latest interest – rate increases by key central banks, including the U.S. Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE). Starting with the Fed, Lin noted that the U.S. central bank only raised rates by 25 basis points (bps) at its 31 January – 1 February meeting, marking a downshift from December's 50 – bps rate hike and a series of 75 – bps rate increases earlier in 2022.
"Much of the reason for the downshift was because inflation rates in the U.S. have moderated," he explained, adding that core inflation rates in other developed countries have also started easing. Lin characterised this as a positive development, noting that central banks around the globe are making progress in taming inflation.
However, the fight against inflation is not over, he said, explaining that there's still more work to do in order to bring inflation back to its target range of around 2%. This explains why the Fed, the ECB and the BoE all raised rates the week of 30 January, he said, noting that both the ECB and the BoE opted for a 50 – bps increase in their key lending rate. Lin added that the ECB signalled it's likely to deliver another 50 – bps rate hike at its March meeting, while the Fed also hinted that it sees further rate increases as likely appropriate.
"The risk here is that the more central banks continue lifting borrowing costs, the more the global economy will continue to slow," he remarked, noting that this increases the odds of a recession in the U.S. and other developed markets. Lin added that strong consumer balance sheets in the U.S. would likely help the country weather the storm a little bit, but that the risk of a recession remains nonetheless.
A recession may be brewing. So why are markets climbing?
The conversation shifted to recent market performance, with Kyle observing that despite the potential for a recession this year, the S&P 500® Index closed at its highest level in nearly five months on 2 February. Lin attributed one of the potential reasons for this to improvements in investor sentiment, especially in the wake of the Fed's smallest rate increase in nearly a year.
"It's important to note that investors don't necessarily always focus on the latest economic developments. Sometimes, they can be driven by other factors as well, such as sentiment," he remarked. Lin explained that Russell Investments' composite contrarian indicator, which measures investor sentiment, has pulled back from the extremely pessimistic levels that were observed throughout much of 2022. Right now, sentiment is hovering around neutral levels and leaning slightly toward overbought – or overly enthusiastic – territory, he stated.
The key takeaway here, Lin said, is that because markets can sometimes be driven by more than just economic developments, it's important for investors to try to stay disciplined. "Don't get too happy just because markets are up, and in the same vein, don't get too panicked when markets are down," he remarked. Ultimately, investors should have a plan that they stick to, Lin said, explaining that doing so will help them make better choices over time.