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There’s no mistaking the shift to more restrictive policies by the US Federal Reserve (Fed) at its last monetary policy meeting: the pace of tapering will double, FOMC members now expect three rate hikes in 2022 and the same again in 2023, and the focus is on combatting inflation rather than full employment at any cost. Whilst not a surprise – the ground had been well prepared in advance – this was nonetheless a major change in direction. It foreshadows a period of dwindling central bank support for the economy and markets, especially as the Fed is not alone.
The Bank of England was expected to announce a further delay, but in fact announced the first rise in its intervention rate. It backed out of this last month, when all observers were expecting the announcement. Many central banks in the big emerging countries, such as Brazil, Mexico and Russia, have already clearly raised rates in recent months to combat extremely strong inflation. And even the most accommodative of the central banks are starting to close the floodgates. The European Central Bank (ECB) and the Bank of Japan have announced the forthcoming end to the asset purchase programmes that were introduced in spring 2020. This leaves the People’s Bank of China standing pretty much alone in this landscape in its resolute support for the weak spots in the domestic economy.
Yet this undeniably restrictive environment does not herald a sudden end to monetary support. One clear example of this can be seen in the combined balance sheets of the Fed and the ECB, which today total over USD 18 trillion, close to double the level at the beginning of 2020. And even if these balance sheets gradually stop growing as asset purchase programmes are wound down, until we see the introduction of a phase to reduce their size, the reinvestment of maturing securities will remain a massive source of liquidity. In addition, central banks have learnt from the experience of recent years, and will be flexible if the solid growth trend currently underway looks like it could be derailed.
For all that, this shift to more restrictive policies will have an impact on the markets for risky assets. Statistically, a period of rising interest rates is not negative for equity markets, provided that the rises are gradual and the timetable is clear. The Fed meeting helped improve market visibility on the trajectory for monetary tightening. However, the risk of a further and unexpected acceleration in the timetable to combat inflation still looms. But what is certain is that marked monetary tightening will not be neutral for investors’ valuation requirements. After close to two years of markets fuelled by massive inflows, often at the expense of any thought of rational pricing, this new monetary era should restore the credentials of the concepts of quality, reasonable valuation, sound balance sheets and pricing power.
Written on 17 December 2021 by Enguerrand Artaz, Fund Manager and Olivier de Berranger, CIO