Major equity markets remain close to their highs for the year, despite a precarious economic situation. The important inflation metrics such as core inflation and services inflation remain elevated, confounding market expectations.
This data, ongoing hawkishness from the Fed and a perception that the banking crisis has been contained, have pushed expectations for US rates higher. The market is now pricing in 5% for year-end US rates, compared to around 4% for year end a couple of months ago, as illustrated in the chart.
Market expectations (futures) for end of year US rates %
Source: Bloomberg from 24 Jun 2022 to 30 May 2023
The end of year rate expectations are now higher than they were during the stable period from October to January but not as high as the period in March just before the banking crisis broke.
We continue to believe that rates have moved so high, so quickly, that certain areas of the economy or financial markets are under material pressure, in addition to a broader pressure being applied to the economy more generally.
Key will be whether rates remain high for a sustained period. Our belief has been that inflation will remain higher for an extended period and, as a result, in the absence of something breaking which could usher in emergency cuts, we believe rates will also remain elevated for some time.
Rarely do markets assess and prioritise a range of risks and opportunities in a balanced manner. Instead, they prefer to focus on single issues and lean towards optimism or pessimism.
Currently equity markets are characterised by big tech marching higher, which is somewhat at odds with the perception that low rates are good for growth stocks. However, big tech had a broadly positive corporate earnings season and is benefiting from the ripple effects of the rerating of artificial intelligence; whether this is sustainable is also very much up for debate.
In this sense, and in other ways, it is an odd environment currently, but our process is quite prescriptive in periods such as this. Fundamentals might well be flashing red, but markets and fundamentals can be divorced for extended periods.
A primary trend has developed in markets, in the form of big tech and, as pragmatists, we have been increasing positions here. We also retain our traditional defensive equity positions and our inflationary positions, reflecting our base case for the economic environment.
Anthony Rayner is a manager in Premier Miton’s macro thematic multi asset team. The views expressed above should not be taken as investment advice.