U.S. Fed, Bank of Canada signal rate hikes likely in March
On the latest edition of Market Week in Review, Director of Investment Strategies Shailesh Kshatriya and Consulting Director Ryan Pogodzinski discussed key takeaways from the recent U.S. Federal Reserve (Fed) and Bank of Canada (BoC) policy meetings. They also chatted about key factors driving the ongoing volatility in equity markets.
Fed indicates March rate increase likely
At the conclusion of its Jan. 25-26 meeting, the Fed left its benchmark lending rate anchored near zero—where it’s been since the coronavirus pandemic struck the U.S. in March 2020—while signaling that a rate hike is likely following its next meeting in mid-March, Kshatriya said. “March looks to be an interesting time, as that’s also when the central bank has communicated its asset-purchasing program will end,” he added.
Fed Chairman Jerome Powell’s comments at the ensuing press conference were interpreted as a bit hawkish, Kshatriya said, with Powell noting the U.S. economy today is on much stronger footing than it was in 2015—when the Fed began gradually hiking rates amid the nation’s recovery from the Great Recession. “Markets interpreted his remarks as an indication that the coming rate-hiking cycle could move at a much faster pace,” he explained.
Kshatriya said that Powell did try to balance out these comments by noting that the risks to the U.S. economy are two-sided, and by saying that the central bank will embrace a humble and nimble approach when assessing the need for future rate increases. “The Fed chair went on to explain that the central bank will be guided by the latest economic and inflation data when evaluating potential changes to monetary policy,” he said.
So, what could this all mean in regard to 2022 rate hikes? In Kshatriya’s view, a March increase is very likely, barring any unforeseen circumstances, with a June increase possible as well. He noted that markets are currently pricing in five total rate hikes this year, which he said could be possible if inflation remains elevated. However, Kshatriya and the team of Russell Investments strategists believe pricing pressures are likely to moderate during the second half of the year, which could lead to fewer rate increases than markets are penciling in.
Bank of Canada also likely to raise borrowing costs in March
Similar to the Fed, the Bank of Canada (BoC) left interest rates unchanged at 0.25% following its Jan. 26 meeting, while indicating that rate increases are in store soon, Kshatriya said. “The BoC was even more explicit in its policy announcement, with officials stating they no longer believe it’s necessary to keep rates pinned near zero,” he noted. This makes a March rate increase in Canada highly likely, Kshatriya remarked. He noted that, just like in the U.S., markets are pricing in five BoC rate hikes through the end of 2022—but stressed that this number may also be too high if inflation does cool down during the second half of the year.
“The key takeaway from the BoC and Fed meetings is that both central banks will be utilizing a data-dependent approach when it comes to potential rate increases this year—which means that the inflation numbers will be carefully watched,” Kshatriya said.
Is the market whiplash hurting growth stocks more than value stocks?
Turning to the topic of volatility, Kshatriya noted that recent days have been marked by extreme whiplash in equity markets, punctuated by an 1,100-point drop—and subsequent recovery—in the Dow Jones Industrial Average on Jan. 24 alone. The stomach-churning volatility is likely due to three key factors, he said, with the first one being the omicron variant of COVID-19. “It’s becoming clear that omicron will likely cause a bit of a hiccup in the economic recovery, both in the U.S. and across the globe,” Kshatriya explained.
The second reason for the volatility is likely due to rising geopolitical tensions between Russia and the U.S. and its NATO (North Atlantic Treaty Organization) allies over Ukraine, he said. “A potential conflict between Russia and Ukraine has broad implications for energy prices—and for several economies in the region,” Kshatriya stated, noting that the situation is very fluid and warrants close attention.
The third, and probably largest, factor behind the volatility is the telegraphing from central banks of multiple rate hikes, he said. This has triggered a spike in government-bond yields, with the U.S. 10-year Treasury yield breaching 1.85% at one point during the week of Jan. 24, Kshatriya noted.
“The jump in yields has had a negative effect on markets overall, and particularly on speculative tech—where cash-flow profiles are further out into the future—as rising rates erode the value of future earnings,” he explained. As proof, Kshatriya noted that the tech-heavy Nasdaq 100 Index was down by 13.5% as of midday Pacific time on Jan. 28, while the S&P 500® Index was off by a lesser amount of 8.5%.
This disparity can also be seen among different equity styles, with the Russell 1000® Value Index—which is more value-oriented—outperforming the Russell 1000® Index by 5% so far this year, he said. Meanwhile, the more tech-oriented Russell 1000® Growth Index has underperformed the Russell 1000 by roughly 4%, Kshatriya noted.
“What we’re seeing is a pretty big spread in relative performance between value and growth stocks, which is why, at Russell Investments, we’re continuing to lean more toward the value factor in our portfolios. Fundamentals are clearly mattering more these days, and markets are becoming more discriminating than they’ve been the past few years,” he concluded.