Active Thinking

At GAM Investments’ latest active thinking forum, David Dowsett discussed the latest developments in markets, his expectations for upcoming monetary policy decisions this week and the continued level of distrust between markets and policymakers.

01 November 2022

Last week was a somewhat better one for risk markets, predominantly driven by increasing speculation about when the Federal Reserve (Fed) will pivot. We are currently seeing broad stability in bond markets, with a yield of approximately 4.5% on 2-year US Treasuries, 4% on the 10-year and 4% on the 30-year. Market sentiment in relation to interest rates was somewhat helped last week by the European Central Bank (ECB) meeting, which was less developed in its talk about quantitative tightening – also perhaps holding out for the possibility that interest rates will not be hiked as much as previously priced in Europe. As a result, we saw 25 basis points (bps) come out of the interest rate curve on Thursday. With that said, the recent inflation data from Europe did not support that rhetoric. We saw 11.6% year-on-year inflation in Germany and 12.8% year-on-year inflation in Italy, both of which were much higher than expected. In addition, core US Core PCE data showed fairly sustained inflation at an underlying level. We are currently seeing quite a lot of back and forth in terms of data one day and central bank rhetoric the next. However, after the very large falls we have seen in markets and sentiment currently being very negative, markets seem to be focusing more on the positive than the negative side at present.

There is no doubt that the Fed will raise rates by 75 bps on Wednesday. The focus will be on whether Chairman Jerome Powell signals that the pace of hikes will be moderated after that. Given the amount of data releases between this meeting and the next, it is possible that Powell will not say a lot, but regardless, that is where markets will be focused. In addition, this week we will see US payroll numbers released which will be important in terms of indicating the health of the US labour market. The Bank of England (BoE) monetary policy meeting will also take place on Thursday. A lot has happened since the last rate rise on 22 September, not least the mini budget. The market expectation is that the BoE will hike rates by 75 bps. Overall, I believe we are just beginning to grapple with the concept of central banks eventually beginning to slow interest rate hikes and I think this is likely to continue for the next few weeks and perhaps even as far as the end of the year.

In Brazil, we saw a narrow win for Luiz Inácio Lula da Silva in the presidential elections. This was arguably the most market friendly result we could have witnessed. Lula, who has been president before, won by a narrow margin and will be constrained by the composition of congress. As a result, he is unlikely to be loose on fiscal policy. Overall, however, the market wanted to move on from former President Jair Bolsonaro.

There is still a significant level of distrust between policymakers and markets. In the UK, for instance, Prime Minister Rishi Sunak and Chancellor Jeremy Hunt have won back some trust. Although they have not announced a great deal yet, the market is presuming that they will be more orthodox than former Prime Minister Liz Truss and Chancellor Kwasi Kwarteng. More generally though, we do not seem to have got far enough along the recovery process that markets are confident in the next step from policymakers. This short recovery period over the last 10 days could be derailed by any data release or surprise from Powell in his press conference on Wednesday.