A closer look at inflation and rates in 2023

The US Federal Reserve on 22 Mar 2023 raised interest rates by 25 basis points (bps) or 0.25%. It also signalled caution and indicated that a pause in rate hikes might possibly be on the horizon. Although inflation remains stubbornly high, this comes in the wake of turmoil in the global banking sector — marked by events such as the failure of Silicon Valley Bank (SVB) and UBS’ rescue of Credit Suisse. The next FOMC meeting will take place on 2-3 May 2023.

In the following list of commentaries, fund managers share their views on what the current policy environment and tightening financial conditions could mean for investors in the stock and bond markets.

To explore best-in-class funds from leading global fund managers, check out the Endowus Fund Smart platform.

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More financial cracks emerge from rate hikes

BlackRock, 13 Mar 2023

“US authorities have acted decisively to protect depositors from the collapse of two regional banks. This is not a 2008 repeat. Yet we see this as an example of economic damage and financial cracks from rapid rate hikes.”

“We recently trimmed our overweight to investment-grade credit and are reassessing our view due to tightening financial conditions. We prefer short-term government bonds for income, even with the sharp yield drop in recent days. The yield slide could quickly reverse as investors see the Fed pressing on with rate hikes. We also prefer inflation-linked bonds amid persistently higher inflation.”

“Most equities aren’t fully pricing the economic damage of hikes, in our view.”

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"Magical Mystery Tour"

Franklin Templeton, 14 Mar 2023

“The prospect of policy rates remaining higher for longer has acted as a reality check on investor sentiment, which might have gotten ahead of itself in the early part of 2023. This helps to reinforce our preference for a moderately cautious view of stocks.”

“Inflation risks are now more balanced: Inflation remains well above target levels, but evidence of peak headline inflation is clear as goods deflation returns. Despite the challenge of the ongoing Russia-Ukraine war, these supply factors are expected to be balanced by demand destruction as the lagged effects of slower economic growth are felt.

“Policy to remain restrictive: Most central banks have adopted a singular focus on inflation and are accepting the consequences to growth. … Central banks are approaching peak rate hikes and becoming more data dependent but will sustain restrictive conditions.”

“Our longer-term analysis shows that the return potential from global bonds, including lower-risk government bonds, has improved. Once the current policy-tightening environment starts to moderate, it is likely that government bonds will again exhibit more of a risk-dampening effect. Until then, we believe bonds still make a more compelling case than they have for many years.”

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What the SVB collapse means for investors

Capital Group, 23 Mar 2023

“The demise of (Silicon Valley Bank, SVB) has dramatically changed the interest rate outlook for the balance of 2023 — and beyond — as the market ponders how the Fed and other central banks will react to growing turmoil in the sector. With fear of contagion spreading, European banks also have come under pressure, forcing regulators to step in and shore up unsteady financial institutions.”

“These rapidly unfolding events have led to an environment where the Fed — unquestionably planning to hike rates just two weeks ago — is now tempering its hawkish tone and may even start cutting rates before the end of the year.”

“The dislocations we are seeing in the financial markets signal a painful new phase for the Fed… We knew there would be consequences to one of the most aggressive tightening campaigns in history. It has clearly exposed some vulnerabilities in the banking system and, as a result, we may be nearing the end of the rate hikes.”

SVB collapse has drastically altered interest rate expectations

“If there’s an expectation that rates are going down, or at least they aren’t going as high as previously thought, growth-oriented companies could be seen as more valuable, particularly the incumbents that funded their growth years ago.”

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Regime shift, monetary policy and shorter business cycles

Schroders, 9 Mar 2023

“The ongoing global regime shift toward higher interest rates and less liquidity will drive transformations of business investment and the allocation of resources. Given structural inflation pressures, we expect central banks will not be able to manage economic cycles as they once did.”

“The inflation narrative during 2021 was ‘transitory’, meaning high inflation was temporary and would not persist. However, last year (2022) when inflation spiked and remained higher than expected, the key term to describe inflation became ‘sticky’.”

“While inflation seems to have crested after central banks sharply increased rates in 2022, our views on labour and energy driving structural inflationary pressures suggest that inflation over the longer term will be sticky above the Fed’s target. This volte-face of the loose money era following the GFC (Global Financial Crisis) could result in rates remaining relatively high to keep inflation from reigniting, limiting central banks’ ability to meaningfully cut rates or loosen monetary policy to shorten a recession or extend an expansion.”

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Fed weighs stubborn inflation against banking system stress

PIMCO, 22 Mar 2023

“To raise interest rates while also signalling increased caution on the outlook reflects the Fed’s ongoing balancing act. On the one hand, the central bankers seek to manage inflation expectations by emphasising their continued resolve to fight inflation, but on the other hand they must acknowledge that recession risks have increased as tight financial conditions and banking sector stress hinder the economy.”

“On net, we believe the stress in the banking sector will work to slow economic activity, demand, and eventually inflation, resulting in the Fed needing to do less to sufficiently tighten financial conditions. As a result, the Fed has likely moved closer to the end of the hiking cycle. However, we note that holding policy at restrictive levels is different from starting the process to normalise or even ease policy. Indeed, the timing and speed of any rate-cutting cycle will depend on how inflation and financial stability risks evolve over time.”

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Noise cancelling: Tuning into central banking signals

UBS Asset Management, 29 Mar 2023

“The Fed has already upped rates by nearly 5% in a year; the ECB (European Central Bank) by 3.5%. It takes time for the full impact of these moves to work their way into all the cracks in the financial system. Policy makers will need to take these growing stresses and strains into more account, even if inflation stays stubbornly above target.”

“The apparent increasing frequency of shocks to the financial system appears to be a signal we are close to peak policy rates in the Eurozone and the US. Much further tightening beyond this point risks a much harder landing than most policymakers could live with. That in itself should limit further downside for bonds.”

“The current situation increases the risks … (of) the rate hikes needed to bring inflation back to target (triggering) an unacceptable round of collateral damage. In which case the debate might move from ‘how to get inflation back to target’ to ‘how to get the target up to inflation’, an altogether more hazardous environment for bond holders.”

‍‍Read more:

• Credit Suisse: A crisis of confidence
• The rise and fall of Silicon Valley Bank
• An uncertain 2023: market outlook survey
• Bonds are back

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Building a long-term resilient portfolio through Endowus

It is impossible to predict how macro events such as this would play out, or to prepare for any consequent implications on your investments. However, spreading your investments across asset classes and geographies will help with diversifying your risk. With market volatility comes opportunities. If you have a long-term investing horizon, as many of us do, these developments may offer an opportunity through steady, regular investing in diversified and risk-adjusted portfolios.

With digital wealth platform Endowus, you can plan and manage your money — by investing in best-in-class funds and globally diversified, intelligent, low-cost funds and portfolios seamlessly.

Click here to get started with your investing journey with Endowus today.

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