Financial Planning & Wealth Management

Higher rates for longer

There’s an old saying that when the US sneezes, the world catches a cold. That’s why I spend most of my time looking to the US.

The chart below shows the S&P 500 (largest 500 companies in the US) year-to-date. After a flying start with the market up close to 20% by August, we’ve seen some sideways movement, and more recently, the markets are starting to slump. They have lost steam. Lost momentum.

Why is this?

Well, we know one of the big factors of 2022 was inflation, and the fight to contain it (interest rate increases).

The rapid rise in the Federal funds rate (the US repo rate) appeared to be effective, and inflation came down sharply. Consequently, there was anticipation that we had successfully controlled it and that interest rates would soon begin to decrease. This development was welcomed by the market, as lower rates not only signify more affordable borrowing but also tend to boost asset prices.

But look at the chart below – there was an uptick in inflation in the last reading.

Chart: US Inflation

Jerome Powell, the governor of the US Fed, has made it clear they want inflation at or below 2%. It’s currently just below 4%. There’s still a long way to go.

There was a belief that elevated interest rates could ‘slow’ or ‘strangle’ the US economy and its workforce, thereby putting downward pressure on prices. If unemployment began to rise rapidly as a result, there might have been a case for initiating rate reductions earlier.

But this hasn’t happened. The US economy has been surprisingly resilient. Look at the unemployment numbers below (look at what Covid did to US unemployment(!))

Chart: US Unemployment

Unemployment ticked up slightly in the latest read, but it’s still below 4%. That means the US economy is at close to full employment.

You may think it’s a good thing that the US economy is strong. But remember, the Fed is focussed on containing inflation. If their economy remains strong and unemployment is below 4%, there’s no reason to lower rates until inflation dips below the target 2%.

These factors are influencing the JSE and the rand (USD is stronger against all other currencies) – both have bombed out in line with the US markets over the past 2 months.

Chart: Dollar to ZAR

The initial expectation was that rates would start coming down at the end of the year or the start of 2024. This no longer seems to be the case.

Since inflation is stickier than originally thought, and since the US economy and their labour market remain strong, it looks like we are going to see higher rates for longer.

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About

 MattFin is a blog that focuses on wealth management, investments, financial markets and investor psychology. I build financial plans and portfolios for families and individuals

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