The Fed signals higher-for-longer interest rates

Chief Investment Officer's team

29 August 2022

Fed Chairman Powell delivered a hawkish speech on Friday at the annual Jackson Hole Symposium

AT A GLANCE

Fed Chairman Powell delivered a hawkish speech on Friday at the annual Jackson Hole Symposium
Markets sold-off sharply in reaction, with the perspective of more tightening for longer
Volatility remains extreme as expected, but we keep our positioning unchanged

Mr. Powell’s speech at the Jackson Hole Economic Symposium triggered a sharp sell-off on Friday. With almost -4% on major US indices, stocks erased more than one trillion in value after the 8-minute speech. In essence, Mr. Powell said that monetary tightening will continue for longer than expected, until inflation abates, through two key points. First, inflation is the core mission of central banks and they have to fight it, no matter if part of it is linked to supply, and regardless of the economic impact. Second, the Fed will continue until data materially illustrates the job is done: lower inflation and expectations. This implies more tightening for longer, continuing into 2023. His speech made several references to the past, especially inflation from the 1970s which only ended in the 1980s, when Paul Volcker’s radical tightening and credit policy, caused the loss of millions of jobs. Chair Powell notably said on Friday that “the historical record cautions strongly against prematurely loosening policy” – and didn’t any more mention a reassuring “soft landing”.

Following and including Friday’s sell-off, developed markets saw a -3.3% weekly drop for equity and between -0.6% and -0.8% for fixed income last week. Emerging markets were better, but of course Asian markets were closed during Powell’s devastating speech and risk aversion should reach them this Monday.

Now that hopes for an imminent pivot are killed, we are to some extent better prepared for an outlook combining anemic growth (resilient in the US, slow in China, contracting in Europe) with monetary tightening and slowly falling inflation. Apart from some unexpected escalation in geopolitics, several asset classes look adequately priced for such a backdrop, which is why we keep our current positioning. Stay safe.

Cross-asset Update

As we highlighted in the introduction, Jerome Powell said Friday that “the historical record cautions strongly against prematurely loosening policy”. Exactly a year ago at the same symposium, he was highlighting very different lessons from the past. At the time, historical records were advising monetary policymakers “not to attempt to offset what are likely to be temporary fluctuations in inflation”, as “responding may do more harm than good”. Those days are gone: inflation is not seen as temporary anymore. But if anything, this 180-degrees turn in a year reminds us of the difficulty of any forward-looking prediction. Actually, inflation forecasts have been wrong for the last 15 years or so, which in a way could be a source of hope, but certainly not a reliable input for investment decisions.

So, let’s have a look at facts, through three points.

First, economic growth: Europe is in a very tough situation with its energy crisis and it will be extremely difficult to avoid a recession. China is in a perilous place, but with vigorous stimulus, which may have started with the stimulus package announced last week (little more than 1% of GDP), and some radical action on real estate, it could do reasonably well, above 3% growth. Finally but crucially, the US looks resilient and looks able to avoid a (severe) recession.

Second, central banks will keep on tightening. However, some inflation measures are already trending lower, even if they remain above target and the comfort zone. To some extent, hawkish communication is part of the tightening toolbox and we prefer to see markets being prepared for the worst rather than dreaming about an imminent pivot.

Finally, certain assets, especially stocks from emerging markets or some safe bonds, are relatively adequately priced for the current outlook: anaemic growth, hawkish central banks and lower but still higher than average inflation. What could change is of course geopolitics. A worsening situation in Ukraine and a simultaneous escalation in Taiwan would be a nightmare scenario. Fortunately, China doesn’t seem to be willing to do more than the spectacular drills which followed the perilous Pelosi visit. With regards to Ukraine, it’s not impossible to think that social unrest in Europe -when insane energy bills reach households- could make political leaders turn a bit less inflexible towards the Kremlin.

Volatility should remain terrifying, which has always been our call for the summer, but the medium-term investment perspectives are not, taking into account what’s priced in and the level of pessimism in the system. Apart from a change in the geopolitical situation, markets should gradually learn to live with the current reality, while the combination of tightening and falling purchasing power should pressure inflation. Inflation has proven it wasn’t transitory, but it doesn’t mean it’s eternal.

Fixed Income Update

Last week ended on a cautionary note for the bond markets. Chairman Powell’s speech at the Jackson Hole symposium seems to have let the cat among the pigeons in the proverbial term. He was clear that rates remain “Higher for Longer.” This would inflict pain on the markets and the economy. However, he also warned everyone against the perils of premature loosening, referring to the lessons learned from the 1970s and early 80s. According to several FED members, the September rate decision remains data-dependent, the most important of which would be the August unemployment report and the inflation data to state the obvious.

The result of the comments was a bear flattening of the curve as the 3-year Treasuries moved up by 20 bps last week to touch 3.47%. This makes bonds with a duration of 3-5 years quite attractive. The 10-year went up by 14 bps and currently hovers around 3.10%. The yield curve remains inverted in the 2s10s part of the curve, though the 3month rate remains below the five-year and 30-year points. The movement in the yields resulted in negative returns across different sub-segments. However, emerging market debt bucked the trend with China’s stimulus starting. We remain cautious on the riskiest segments with higher FEDs for longer rhetoric. This week we could see most of the gains of Emerging Market Debt being given up.

Looking Eastward, there was a bit of relief for Chinese property developers. There was a sharp weeklong rally driven by news that some more vital private developers were preparing to issue RMB corporate bonds with guarantees from China Bond Insurance Company. However, the recent policy easing is unlikely to be extended to the most stressed private developers. Therefore, tail risk will remain fat within the China property sector.

According to recent Goldman Sachs report, flows into global fixed income funds were slightly negative (-$1bn vs. +$0.4bn in the previous week), mainly on outflows from EM across hard, blended, and local currency funds. On the other hand, flows across DM bond funds were mixed, with high-yield funds seeing the most significant net outflows as a percentage of AUM. Overall though, flows into DM were positive, as government funds saw a resumption of net inflows and Agg-type funds continued to see strong demand.

GCC bonds saw a differentiated performance. According to trader notes, Abu Dhabi performed well within the IG space while the KSA long ends lagged. High Yield sovereigns sold off, with Bahrain outperforming the Oman bonds complex. Regarding corporates, Acwa Power lost its IG rating as Moody’s downgraded it from Baa3 to Ba1. There has been a staggering 75% drop in primary issuance from the GCC region. ADCB announced a USD 5y green bond last week with roadshows starting this Monday. If this deal comes to the market, it would be the first primary issuance in the region since late June.

Equity Update

Global equities ended lower for the week, down 3%. Looks like the sunny summer is over for the markets with the Fed path and recession fears in the forefront again. 2Q earnings supported markets and guidance was not overly negative, but evidence of weakening demand, shifts in consumer spending with inflationary pressures increasing and inventory pressures for retailers stood out. The full impact of rate hikes on growth and earnings will become more visible in the coming quarters. US equities were down -4% for the week, with most of the fall on Friday post Fed Chair Powell’s more hawkish stance amid the backdrop of the mixed inflation data and the strong July job growth figures. Another "unusually large" rate hike could be appropriate at next month's Fed meeting even if it means some pain on the economic front. So far, the economy is holding up as illustrated by worker demand, a recent durable goods report that reflected a monthly uptick in business investment and big retailers with strong sales figures, a reflection of continued strength in US consumer spending. US treasuries have recently been volatile with the 2/10 yield curve steepening but remaining inverted, and the U.S. dollar has hit a new multi-decade high, affecting high growth sectors and those with large overseas earnings. The ECB is tailing the Fed but the high energy costs necessitate rate hikes and the economy and consumer in the Euro bloc appear less able to weather the tightening with possible energy rationing in winter for industrial users.

We had recently moved to a neutral Asia and China positioning from an overweight position, tired of all the to and fro-ing by regulators promising to ease up on tech companies and waiting for China’s economy to kick start post continuing lockdowns. Domestic travel is resuming but international travellers still face quarantining and few flights operate internationally. Whist the real estate slowdown remains a drag on the economy and on banks there are some green shoots. The US and China are close to an agreement to allow US regulators access to audits of Chinese companies that are listed on US exchanges. ADR’s of Baidu, JD.com and Pinduoduo, have been trading higher in hope of a resolution. Earlier this month, five state-owned Chinese companies said they would be delisting from US exchanges before they get ousted in 2024 as a result of the pending ban. We advocate a market neutral weight for China equities.

Other Asia economies and markets continue on an uptrend. The UAE had another week of gains amidst real estate developer Emaar Properties announcement to vote for an increase in Foreign Ownership Limits. UAE corporates have been slowly raising eligibility for foreign owners as have KSA listed companies and the regional weight of the GCC in the EM index is currently 8%. Relaxed FOLs would lead to a further allocation to the GCC and consequent passive and active flows.

We have a close to neutral outlook for equities and as we said at the beginning of the summer, markets will continue to react to Central Bank rhetoric, inflation and geopolitics. Earnings remain the most important determinant of equity performance, hence selection remains key with a preference for regions, sectors and corporates with resilience in earnings growth.

Written by:

Anita Gupta Head of Equity Strategy , Anitag@EmiratesNBD.com
Giorgio Borelli Head of Asset Allocation , GiorgioB@EmiratesNBD.com
Maurice Gravier Chief Investment Officer , MauriceG@EmiratesNBD.com
Satyajit Singh Fixed Income Analyst , SatyajitSI@EmiratesNBD.com

Disclaimer

IMPORTANT INFORMATION

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), licensed and regulated by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”) and subject to regulation, supervision and control of the Central Bank and SCA, having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

Data/information provided in this document are intended solely for information or illustrative purposes and are not designed to initiate or conclude any transaction.

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accepts no responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they maynot be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investormay lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.

more app

Auto Loans