Market Update

We've experienced a whirlwind week filled with central bank monetary policy meetings, resulting in a flurry of interest rate hikes. This hectic week culminated in a mini-budget announcement in the UK on Friday, September 23, 2022, set against the backdrop of escalating geopolitical tensions fueled by Vladimir Putin's heightened rhetoric regarding Ukraine.
As you'll observe in the accompanying table, it was an unfavorable week for global equity markets, with the exception of Turkey, where the central bank reduced interest rates by 1%. Several central banks, including Sweden's Riksbank (up 1%), Switzerland and South Africa (both up 0.75%), and the Norges Bank in Norway (up 0.50%), raised interest rates.
However, the most significant developments, given the deteriorating economic growth, were the announcements from the Federal Reserve (on Wednesday, September 21, 2022) and the Bank of England (on Thursday, September 22, 2022).
As widely anticipated and priced in by financial markets, the Federal Reserve policymakers increased US interest rates by 0.75%, marking their third consecutive 0.75% hike. The accompanying statement held no major surprises, as policymakers have consistently emphasized their focus on restoring price stability.
What came as a shocker was the release of their 'dot-plot.' The dot-plot illustrates each policymaker's interest rate projections for the next three years. This week's revised dot-plot not only indicated that US interest rates would be 1.25% higher by year-end but would also remain elevated for the following two years.
We believe this impatience on the part of Fed policymakers may lead to an unavoidable US recession. By raising interest rates too aggressively and rapidly, they risk becoming akin to Milton Friedman's 'the fool-in-the-shower,' who gets scalded by hot water after turning the hot water all the way up because the shower initially delivered cold water. In other words, Fed policymakers are aggressively hiking interest rates without adequately considering the consequences of their previous increases.
The eventual result, in our view, will be a realization (likely in 2023) that they've overdone it, prompting a course reversal – a development that could benefit global equity markets.
In contrast, the Bank of England resisted the trend of jumbo interest rate increases seen elsewhere and opted for a more modest 0.50% hike. Although the three-way split in policymaker voting (with five members supporting 0.50%, three favoring 0.75%, and one supporting 0.25%) added an element of intrigue, it quickly became secondary to the mini-budget announcement today.
Given the fiscal policy changes revealed, financial markets have now priced in a 1% interest rate increase when the Bank of England policymakers convene on November 3, 2022. This is likely to exert significant pressure on homeowners with variable rate mortgages or those whose fixed-rate deals are set to expire soon.
While many of the announcements had already been leaked, the primary surprise for us was that Kwasi Kwarteng focused primarily on reversing previously announced tax increases, implementing tax cuts, and introducing supply-side reforms. There was minimal mention of revenue-raising measures.
Regrettably, as it wasn't a full budget, there was no accompanying assessment from the Office for Budget Responsibility (OBR). Consequently, there were no growth or inflation forecasts to gauge the impact of the policy changes. Financial markets reacted negatively, leading to a sell-off in both the pound and gilt prices. Unfortunately, a weaker pound is likely to exacerbate UK inflation, as it will drive up the cost of imports.
It's worth noting that any OBR assessment is somewhat speculative, as the eventual cost will depend on global energy prices. The government's £2,500 energy price cap effectively represents an open-ended commitment, contingent on factors like the severity of the upcoming winter and developments in Ukraine and Russia.