Interest-rate rises mean more pain for stocks

The position of central bankers today “recalls an old joke about a cab driver telling a lost tourist asking for directions: If I were you, I would not be starting from here”, says John Plender in the Financial Times. The Bank of England has warned that inflation will top 10% later this year while issuing gloomy growth forecasts. As central banks “try to engineer a soft landing” the risk of a “policy error” that crashes the economy is high.

“The Bank of England is skirting around the ‘r’ word but its grim set of growth forecasts all but confirm that the UK is heading for a recession next year,” says Mehreen Khan in The Times. Policymakers last week raised interest rates by 0.25 percentage points to 1%, the highest level since February 2009. Three of the nine members of the monetary policy committee wanted to go further and voted for a 0.5% rise. Markets now expect UK interest rates to keep rising until they hit 2.5% next year.

Racing out of control

“For more than a year now, Threadneedle Street has kept its head in the sand”, even as it became clear that inflationary pressures in commodity and labour markets were racing out of control, says Liam Halligan in The Daily Telegraph. Policymakers argue that the war in Ukraine has changed the outlook, but that is nonsense. In January – pre-invasion – “CPI inflation was already at 5.5%, a 30-year high”. Caught behind the curve, the bank will now have to raise rates faster, inflicting unnecessary economic pain on households in order to “slay the dragon” of price rises and win back some of its battered credibility.

In America, the Federal Reserve has gone further. Last week it raised interest rates by half a percentage point and also started the process of unwinding “its huge bond holdings”, says the New York Times’ DealBook. The move “signals urgency” about getting inflation back under control. Fed chair Jerome Powell said that further half-point increases are “on the table”. Until recently the Fed had “believed that inflation would ease as supply shortages moderated and as the economy evened out after early-pandemic disruptions”. Now renewed lockdowns in China and the war in Ukraine mean that “the notion of a return to some kind of pre-pandemic normal without intervention has been abandoned”.

Stockmarkets are getting the message that the Fed is serious about tighter policy. The S&P 500 has suffered five consecutive weeks of losses, its longest losing streak since 2011, and is down more than 16% since its peak. That’s the worst four-month start to a year since 1939 and a technical bear market (defined as a 20% drawdown) seems imminent. On Monday, global shares, as measured by the FTSE All-World index, had their worst day since June 2020.

“Unfortunately for investors, the Federal Reserve probably doesn’t feel their pain,” says Justin Lahart in The Wall Street Journal. In the past the Fed has taken pains not to sink the stockmarket, but today inflation-fighting has become its priority. With valuations still high and US labour markets robust, they have little reason to pause the rises. There is likely plenty “more pain in store for stocks”.