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Staving of ‘inflacency’ and what it means for markets

Fixed Income

Markets were caught off-guard this week by news that the Federal Reserve had become more hawkish than expected. The issue that gained all the headlines was the fact that Federal Open Market Committee (FOMC) members now expected interest rates to increase twice before the end of 2023; a year early than expected. Further, 13 of the 18 members now expect at least one increase before the end of 2023, versus just seven in March.

Despite long-held concerns that any sign of interest rate increases would see the sharemarket capitulate, it was surprisingly resilient. According to Steve Miller, Investment Strategist at Grant Samuel Funds Management, this may be due to the fact that “the Fed appears to have staved off – for now – a charge of ‘inflacency’.”

According to Miller “inflacency” is complacency about inflation, which many high-profile hedge fund managers and investment bank heads had flagged as a significant concern as the Fed appeared to be getting out of touch.

  • Whilst the Fed meeting was full of disclaimers like ‘the dots should be taken with a grain of salt’ and any discussion about raising rates would be ‘highly premature’ Miller highlights a risk in the new ‘outcomes-based’ approach the central bank is now taking. Outcomes-based he explains is the new framework where they have indicated ‘it acts only if inflation persistently surprises on the upside’.

    Quoting ex-Prime Minister Paul Keating, he suggests that this increases the risk of an ‘overshoot’ and could potentially mean the ‘inflation genie might well be persistently out of the botte’. 

    In his view, this could mean the Fed ‘has to jam down hard on the monetary brakes’ an event that would send bond yields higher and result in a significant correct in equity markets. Of greatest concern however is the ‘major challenge’ facing multi-asset investors, including advisers, as correlation between these two asset classes moves in unison.

    Therefore, the June meeting of the FOMC was a positive in Miller’s view, as it ’Chair Powell appeared keen to indicate that the Fed was projecting an orderly and conditional retreat from historically high levels of monetary accommodation’ whilst also being ‘careful to address perceptions that the Fed was not prepared to address growing inflation concern’.

    Miller draws attention to the fact that the FOMC raised its projections for economic growth in the US, with GDP expanding 7 per cent in 2021, up from 6.5 per cent. It also maintained the 2022 expansion forecast of 3.3 per cent and raised the 2023 estimate to 2.4 per cent. It is interestingly to note the ‘base effects’ that are driving the 7 per cent 2021 level of growth will also result in lower growth in 2022 and 2023 by comparison.

    GSFM’s Investment Strategy is keenly on the side of inflation as a growing risk, noting that the annual rate based on the last three months is close to 8.3 per cent, the highest since 1982.

    He highlights a number of inflationary pressures ranging from the US$2 trillion in savings set to be unleashed, continued debt purchases, booming property prices and the Biden agenda which is set to trigger higher wages, stronger unions and greater employee benefits.

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