Evening Brief – 09.22.23
Equity Investors Have Agita
This week global central banks emphasized their continued concern about the risks of inflation and cautioned investors against expecting interest rate cuts too soon.
The growing possibility that monetary policy will trigger a recession is leading investors to sell stocks at the quickest rate since December. According to market strategist Michael Hartnett of Bank of America, equities funds lost $16.9 billion in the week ending September 20.
The thought of interest rates remaining higher for an extended period of time has given investors agita, and the positive summer mood has deteriorated this week. Many investors had thought that by the end of 2023, we would have a better idea of when the first interest rate cut will take place.
Instead, the Fed’s comments that it is willing to hike rates more if needed and maintain a tight policy until there are clear indicators that inflation is returning to target levels have complicated that scenario.
Despite the fact that US equity markets were higher on Friday after a brutal week that pushed stocks to their lowest level in over a month, investors are compelled to accept the prospect of higher-for-longer interest rates.
Equities are anticipated to continue to struggle as nominal and real yields rise, which are projected to continue to move higher. For all of this year, the thinking has been that interest rates would peak and decline. However, such wagers appear to be fading in the aftermath of the Federal Reserve meeting and press conference on Wednesday.
The nominal 2-year yield has been trading below the effective Fed funds rate, implying that the market believes interest rates would peak and then turn lower. However, this perspective appears to be waning as the 2-year yield, presently at 5.15%, approaches the Federal funds range of 5.25% to 5.50%.
Meanwhile, the 2-year real (inflation-adjusted) yield is trading around 2.25%, rising over 50-basis points since the end of last month.
“It’s a real rate that will matter and that needs to be sufficiently restrictive,” noted Fed Chair Powell in his press conference.
The plus side for investors is that a buy-and-hold strategy can lock in the best yields in about 15 years, either real or nominal. Nobody knows if current rates are at or near a peak, but one thing is certain: the case for a bigger allocation to Treasuries compared with recent history hasn’t looked this good in years.