Vibrancy in Rate Markets

Investor optimism has significantly improved since the global rate tightening cycle began in 2022. Investors may even look at capital markets today and think this is the best of both worlds regarding stock and bond returns. On the one hand, public equity markets have had an incredible start to the year. Practically speaking, many believe the bear market triggered by the higher interest rates now lives in the background. On the other, bond yields provide meaningful investment returns that went missing for over a decade when global policy favored extremely low-interest policies.

Overall, inflation rates have declined worldwide since peaking last summer. The reversal has renewed optimism in global asset prices. Regarding global leadership, the US seems to be ahead in slowing the inflation pace in its local currency. The rest of the world and non-US dollar currency competition appears behind. Certain countries, such as Japan and China, may even be experiencing demand-related problems, making inflation nearly nonexistent in their local currencies. Moreover, China started stimulating its economy with new money, making them one of the outliers in global macro. But, at least inflation in developed market currencies has declined without significant loss to global output. We may be experiencing an economic “soft landing” due to the orchestrated interest rate hikes, which investors saw as an unlikely outcome at one time.

One of the larger surprises in June was the Bank of England’s aggressive interest increase. The news shook markets for a brief moment, but it quickly faded as investors realized the UK’s problems were beyond the scope of an oversupplied gilt market. More specifically, UK inflation is possibly difficult because of the European Union exit. Still, what’s happening with UK interest rates and the British pound may be meaningful because of the trillions invested in UK pension funds.

Offering no surprise in June, the Federal Reserve decided to keep interest rates unchanged. The Fed was able to pause, given that US inflation has moderated, economic growth persists, and US interest rates are ahead of the rest of the world. US resilience has likely given the US dollar an extremely competitive advantage this year. As a result, foreigners seem to want US dollar investments due to the appearance of wealth stability provided by US assets. This non-domestic demand has helped support US asset values and America’s global purchasing power observed through the trade deficit.

Unfortunately, the end of this restrictive rate cycle doesn’t appear to be in sight quite yet. Markets are almost fully expecting another 0.25% interest rate increase in July. Presently, markets are indicating this increase will be the final adjustment. However, Fed forecasts might be at odds with market predictions, thinking two more rate hikes might occur before year-end. Final interest rate levels are unclear and depend on certain macroeconomic forces, such as prices and employment. Still, bond markets presume the end of this rate cycle might be six to twelve months away based on the interest rates inferred in the inverted yield curve.

Monetary policymakers typically try to monitor and adjust short-term rates as one of their key monetary policy tools. However, long-term interest rates are usually left to the free market to sort out. So far, long-term rates have remained fairly stable this year. But today’s hot labor market in the US may be putting pressure on long-term rates. That is something investors are watching carefully. Investors remain uncertain if short-term rates will one day lessen to meet long-term rates or vice versa. Of course, the actual course of time and interest has meaningful investment implications along the way.

Fortunately, investors don’t have to be experts in all of the variables that impact global macro when planning for their financial futures. Focusing on those things we can control, such as formulating intentional financial plans and building proper portfolio diversification, is a foundational principle that can lead to successful financial outcomes. These areas of focus are increasingly important in the midst of the evolving monetary policy, interest rate levels, and inflationary environment.

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