Our outlook for 2022 has been that the rate of change for economic growth and inflation would slow compared to 2021. In prior historical periods when this has occurred, long-term interest rates have declined. This has been especially true when the Federal Reserve has been increasing short-term interest rates. Thus far in 2022, long-term interest rates have increased. The difference in this period may be driven by the way the Federal Reserve has been talking about future monetary policy plans, as other market signals are not suggesting that economic growth and inflation are going to accelerate in a manner that would warrant higher long-term interest rates.
In the last two weeks, several Federal Reserve members have been publicly discussing the need to tighten policy aggressively and quickly, and the release of the minutes from the latest Federal Open Market Committee (FOMC) meeting suggested that there is broad agreement around this view (the lone dissenting vote wanted to be even more aggressive). This policy shift to continually reiterate the need to be aggressive for a sustained period has led to a market reaction of pricing in a series of rate hikes, even though the actual rate has only been increased by 0.25%. The futures market for one-month rates one year from now is over 3.0%, up from 1.5% at the beginning of March. Treasury market interest rates increased again during the last two weeks, with the biggest move taking place in the 10 year. The middle portion of the yield curve remains inverted, where seven- and five-year rates are above the 10 and 30 year, and the three year is above the 10 year. The biggest change in the shape of the yield curve has been the spread between the two year and the longer maturities.
In prior periods, the FOMC has been less open about how aggressive they plan to be, and they typically state it will depend on the data they track and whether they think it is necessary to continue to move in that direction. The guidance on future rate hike plans has the most direct impact on longer-term Treasury rates, which is the strongest evidence that interest rates will increase. Other market signals that are not directly influenced by FOMC policy are not suggesting that growth and inflation are going to continue to increase.
In equity markets, the strongest performing industries outside of Energy (response to high oil) have been Utilities (all-time high), Health Care (all-time high), Consumer Staples (all-time high), and Real Estate. These industries tend to outperform during periods when economic growth and inflation are slowing and interest rates are declining.
The U.S. Dollar Index (DXY) is at a two-year high and has been outperforming non-commodity related developed market currencies. Historically, the U.S. Dollar has performed best in periods when economic growth and inflation are slowing.
Gold has been steadily increasing in 2022 (even as interest rates have increased), and while it is down 5% from the recent high, it increased last week despite another move higher in interest rates. Gold has historically performed best when interest rates (mainly real rates) are declining, and economic growth and inflation are slowing.
These market signals that are not directly influenced by guidance on future FOMC interest rates hikes are reflecting investor expectations for an increased probability of slowing economic growth and inflation.
In the coming weeks, economic data for the month of March will start to be released, which is the first period when the year-over-year comparison set will start to get more difficult. Companies will also start to report first quarter earnings and update guidance for 2022. The earnings comparison set for the first two quarters of 2022 is very difficult. These data points should start to provide more insight into how the economy and private sector are performing, and the market reaction will provide more information into investors view on the likelihood of higher interest rates away from areas most influenced by FOMC guidance.
Vice President, Research and Strategy
Boyd Watterson Asset Management, LLC
Vice President, Research and Strategy
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