Interest rates

Rapid inflation and interest rates discourage buying stocks

We are approaching the point where the Federal Reserve has enough done lower inflation next year. Putting aside past mistakes of creating too much money and buying too many bonds, it now recognizes that it has kept rates too low for too long. It raised short rates to 3-3.25% and signaled that they will be closer to 4.5% by the end of the year.

It launched a massive bond-selling program to help push up the interest rate on longer-term borrowings. The danger now is that he raises rates too high for too long, turning the coming downturn into a recession.

The European Central Bank is even further behind in raising short rates and does not want to sell any of the large stocks of bonds it holds in the market. Inflation is upper in Europe than in the United States and it will take more action to bring it down.

The Bank of England started to rise earlier than the Fed or the ECB and raised long rates, but is currently between the two on short rates. China is able to gently cut rates and has relatively low inflation, while Japan is keeping rates at zero as it finally sees some inflation emerging.

Most bond and equity markets and portfolios fell in 2022 as rates were raised sharply from ultra lows to belatedly fight rising prices.

Longer bonds have suffered a lot, as they always collapse faster when interest rates rise. If rates drop from 1% to 2%, a bond offering 1% with no call date will halve in value, so the £1 fixed income on £100 of bond becomes 2% income on the reduced value of £50. A 1 year bond paying 1% will fall by around 1%, so when you redeem you get £1 of capital gain to add to your £1 income.

Now that you can get a much better return on income and there have been such big drops, I’m starting to invest some of the money in longer term US bonds.

Despite substantial cash instead of longer bonds this year, the global FT fund also fell as stock values ​​fell. The biggest holding is in global equities, seeking maximum diversification as well as a bit of defense.

Domains that have done so well in previous years as the digital and green revolutions advanced have fallen on hard times this year, so it was only right to drastically reduce their exposure ahead of the sale. A Nasdaq ETF was the biggest holding I narrowed down. It would have been better to have also sold all the digital specialists.

So the main question investors need to ask themselves is how long and how deep will the recession be? It’s just taking shape. In the United States, digital giants report more difficulties in maintaining sales growth and margins. Ad revenue is harder to come by. Mortgages at rates of 6 or 7 percent have led to a slump in home buying and a need for builders to reduce and sell inventory.

We expect further earnings downgrades and tougher business conditions for many companies over the next year as severe monetary tightening takes effect. The United States benefits from its strong domestic energy position with a surplus of natural gas.

China, the world’s second largest economy, no longer offers as much support to global growth as before. Tracked by rolling locks cities and regions to pursue its net zero policy, production is not increasing at a pace comparable to pre-Covid.

President Xi Jinping has assumed more power and placed many more of his supporters in key positions. He opted for a more communist policy, with more activity channeled through nationalized industries. It continues its crackdown on parts of the free enterprise sector and seeks to eliminate excesses in the world of ownership that had accounted for substantial increases in production.

China’s poor human rights record, growing intervention in prices, earnings and business activity, and a desire to drive zero Covid ahead of recovery do not make it a prospect. attractive to Western investors, although it should rebound on any decrease in foreclosures with monetary stimulus.

The world’s third largest economy, Japan, is finally getting some global energy price inflation, but with core inflation still below 2%, it continues with zero interest rates and sluggish growth. The very weak yen is starting to worry the authorities.

The EU is suffering greatly from the war on its doorstep and the energy shortages caused by the need to end dependence on Russian gas and oil. There will be recessions in various European countries over the next five quarters, made worse if the ECB tightens too much.

The EU is struggling to agree on Europe-wide policies on sharing energy resources and subsidizing those in need. Germany has established a €200 billion offset program to help German industry and consumers – measures resented by other states that cannot afford something similar.

It is still not possible for the markets to expect a superficial and short slowdown followed by a good recovery. No advanced-economy central bank is yet ready to suspend actions to rein in inflation, and none will lead us to expect falling or even flat rates in the near future. Corporate margins have reached very high levels and are expected to decline as the cost of living crisis makes consumers more cautious.

It is always painful to come out of rapid inflation, and there remains the danger that central banks will overcorrect past mistakes. The brutal war in Ukraine continues, but some of the worst supply shortages, such as microprocessors, are easing. Commodity prices generally weaken as people eye falling demand in a downturn, despite OPEC cutting oil supplies and Russia threatening some of the grain trade Again.

It is not yet time to increase the equity portion of the fund and it is not yet easy to guess which sectors and areas will respond best to the recovery when it comes. The money is destined for more bonds as we approach a pause in rate hikes.

Sir John Redwood is Charles Stanley’s chief global strategist. The FT fund is a fictional portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global equity markets while reducing investment costs. john.redwood@ft.com