Analysts divided on bad news

• Some think the economic effect of aggressive tightening of monetary policy is yet to become evident

Global financial markets have endured a torrid 2022 after central banks around the world aggressively tightened monetary policy to curb rocketing prices. But analysts are divided as to whether markets have priced in all the bad news that comes with higher interest rates.

Global financial markets have endured a torrid 2022 after central banks around the world — with the notable exception of Japan — aggressively tightened monetary policy to curb rocketing prices in the wake of the pandemic.

Worsened by a combination of shocks, including the effects of the Russia-Ukraine war, and supply chain bottlenecks, the likely result is that inflation will remain well above many countries’ targets for longer than initially expected.

By June, inflation reached 8.6% in the US — a 40-year high and more than four times the Federal Reserve’s 2% target — and 9.9% across the EU in September. SA was not spared, with the consumer price index touching a 13-year high of 7.8% in July.

Since March the Fed has raised rates six times. The benchmark is now at 3.75%-4%, the highest since 2008, after a fourth straight 75 basis-point increase at its last meeting on November 2.

The European Central Bank, initially slow to react, hiked rates for a third consecutive time with the latest by 75 basis points in October, taking its benchmark to 1.5%. Before the hiking cycle began, rates in the 19member bloc had been negative since 2014.

The SA Reserve Bank, which seeks to keep inflation between 3% and 6%, has raised its repo rate by a combined 3.5 percentage points since it kicked off its tightening cycle in November 2021. That included a 75 basispoint increase at its most recent meeting, on November 24, taking the benchmark to 7%, higher than it was before the pandemic struck.

Still, analysts are divided as to whether markets have priced in all the bad news that comes with higher interest rates.

Old Mutual Wealth investment strategist Izak Odendaal believes they have.

“The immediate impact of the increase in interest rates across the world — the first bomb to drop as it were — was a record slump in global bonds, a bear market in equities, and a surge in the dollar,” he said. “This is largely priced in now.” Though rates could go still higher, “the bulk of the increases are probably behind us”, Odendaal said.

“The next bomb to drop will be the economic impact of the higher rates. It is, however, more difficult to know to what extent this is priced in.”

Carmen Nel, economist and macro strategist at Matrix Fund Managers, said the outlook is not entirely clear. “The recent rebound in US equities suggests that the probability of recession [there] has declined, but the US yield curve remains firmly inverted [interest rates for longer term debt are lower than those with a shorter term to maturity] and this has historically been a reliable indicator of a sharp slowdown in growth or recession,” she said. “As such, it is not obvious that all of the bad news is in the price.

“To some extent, the reset in real yields has accounted for the bulk of the market volatility during the year, but the decline in earnings that should ensue as the recession unfolds would put renewed pressure on equities in the medium term,” Nel said.

Malcolm Holmes, head of portfolio management at INN8 Invest SA is more pessimistic, noting that markets historically have tended to overestimate the pace at which US inflation drops from high levels.

“The recent rally in global equities has been driven by the market pricing in an imminent pivot in interest-rate policy by the Fed. However, we believe this is premature as the Fed still has a long way to go in restoring its inflation credibility. Accordingly, we think the market is currently underpricing future risks. Besides a rollover in US house prices, there is little other evidence of the impact of these interest rates hikes on the economy,” he said.

“The bad news associated with a US recession and further earnings downgrades is likely a story for the first half of 2023. Only once that shoe has dropped, and a path to lower interest rates has been identified, will the market feel comfortable in moving back to its historic highs.”

At a recent press conference Fed chair Jerome Powell said the central bank still had “some way to go” and its reading of the economy since its September meeting suggests that interest rates levels will be “higher than previously expected”.

In September, officials projected that rates would rise to 4.5%, but markets are now expecting an increase to above 5% according to data compiled by Bloomberg.

‘THE BAD NEWS ASSOCIATED WITH A US RECESSION AND FURTHER EARNINGS DOWNGRADES IS LIKELY A STORY FOR FIRST HALF OF 2023’