4 April 2022 - Interest rates debates are back




Equity markets consolidated close to their recent highs, with Europe out-performing the US and China extending its recovery. It was a week when the focus returned to the new interest rate environment which has evolved since the start of the year, primarily in the US. The FED has decided to act aggressively in order to tackle inflation and the bond market has responded accordingly. The yield on the 2-year bond (2.47%) is now higher than the 10-year (2.41%) an event which is called “yield inversion”, meaning that the short-term rates are higher than the long-term rates. This phenomenon has been associated in the past with an economic recession coming, but one should remember that this can happen one or two years after, as history has shown. We should note that we are entering a traditionally good month for equities, as dividends are getting paid in Europe and financial reports for the first quarter are about to begin.


Defensive sectors (healthcare, real estate consumer staples) performed better than the economic-sensitive ones (financials, energy) in the US, as the market took notice of the yield inversion and started to prepare, perhaps prematurely, for a recessionary environment. The fact remains that the economy is going to slow down, which is the purpose of the FED’s actions to begin with. But an outright recession (negative GDP growth for two quarters) does not appear to be imminent. Still, the presence of defensive sectors in the portfolios should be maintained and enhanced on any weakness.


Two more FED members are publicly in favor of an 0.50% increase in interest rates in the May meeting. This comes after the FED’s Chairman himself has pointed to this a few weeks ago, and one must consider it now a certainty. If nothing changes in the economy or the world in the next six months, one should expect that the USD short term rates should reach 2% by year end. Economists are forecasting that this rate could even reach 2.5% in a more aggressive scenario, but the “good thing” is that in 2023 there could be no more rate hikes, as the FED will probably pause in order to assess the effect of the change of its monetary policy on inflation and the economy.


The Eurozone March Inflation numbers were mixed. The CPI rose to 7.5% on a yearly basis against expectations for 6.7%, but the Core CPI (excluding food & energy) rose by 3.0%, less than the expected 3.2%. Of course, we have yet to see the full effect of the Russian sanctions on food and energy in the coming weeks.


The March labor market report in the US was strong. Nonfarm payrolls rose by 431’000, slightly higher than expected, but there were large positive revisions also in previous months’ data. Unemployment fell to 3.6%, while wages rose further. Referring to our recent report “Lessons from the 1970s” the job market is too strong, and the FED will actually engineer a rise in unemployment in order to slow the economy and bring inflation down. If any lesson was learned from the dreadful 70s in the US is that when inflation is getting out of control, one stops worrying about a potential rise in unemployment and attacks inflation almost “at any cost”. The 3.6% unemployment rate gives huge room to the FED to go “all-in”, when it comes to interest rate hikes.


China seems to be close to an agreement with the SEC, the capital markets authorities in the US, with respect to offering more transparency for the Chinese companies listed in the US. As a reminder, the SEC has given a deadline to these companies to comply or face de-listing. Shares of Chinese powerhouses such as Alibaba and Tencent are now more than 50% higher from their lows in mid-March.


Russia and Ukraine continued their negotiations in Turkey, with some progress made. Russia has accepted to reduce its military activities in the north and Ukraine seems warmer to the idea of a “neutral” country and no NATO membership. However, no one really knows when and how this conflict will end.


Oil prices fell below 100$ for the WTI Crude, as the US administration announced the release of 1mn barrels per day from their strategic reserves, for a duration of six months. This would be the largest release of strategic reserves in history, if it finally takes place.




Charts of the Week


This is the chart of the yield of the Emerging Markets Bond index in USD, for the last 10 years. One can see that historically the yield has moved in a range of 5.0% to 6.0%. During the pandemic and due to the extra monetary measures of the major central banks that led interest rates to zero, the yield reached a historic low of 3.5% which was not sustainable. As mentioned several times before, when yields rise bond prices fall and the opposite holds true, when yields move lower, then there is capital gains on top of the coupon earned. The rise of yields in the US Government bonds since the 4th quarter of 2021 together with the sell-off caused by the Russia-Ukraine situation has caused the yield of Emerging Market bonds to shoot up to almost 6%, in USD. These levels in the past have been very attractive to enter this asset class and it could prove yet again such a similar entry point. An investor who buys at these levels, “locks” yields of about 6% and has the potential also for capital gains if the yield moves again towards 4%, as it has happened in all instances in the past 10 years. Of course, investing in Emerging Markets carries significant risks and diversification is fundamental.



Significant technical developments have taken place in March in global equity. We had discussed a few weeks ago the beginning of a military conflict usually marks the bottom of markets, which then move higher as they are looking already at the next day. On top of that, March is also usually a month that big drops or bear markets find their bottom. What we had witnessed historically has also held true this time also. Going back to the above chart, we can see that the S&P500 broke out of its downtrend (red dotted lines), which was in place since the end of last year. The move accelerated further when the index also passed over the 200-day moving average, which is currently at 4495 (not shown in the chart). Given the fact that April-May are historically good months for equities and the earnings season in the US it is about to start, one should expect that we have seen the bottom of the market for the next 2-3 months and that the index should trade in the range of 4350-4650, which is 2-3% around the current levels. Moving into the summer would be a different story, as we will know by then the FED’s decisions as well as the effect of high commodity prices to the economy.





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