MONTHLY UPDATE: Inflation – sticky, stubborn, and still a concern
When will inflation fall to more manageable levels? How high will interest rates rise and for how long? These key questions continue to weigh on investors’ minds and drive the performance of financial markets.
And we’re not out of the woods yet. Lilian Chovin, Head of Asset Allocation at Coutts, says there’s still significant room before interest rates reach their ceiling.
“Although at the start of the year inflation appeared to have peaked, US consumer prices rose by more than expected in January,” he said. “There’s evidence suggesting America’s economy may avoid a recession, at least in the near term, but inflationary pressures are proving sticky.
“As a result, the US Federal Reserve may have to raise rates further and hold them there for longer.”
It’s a similar story in the UK and Europe. There are signs both could avoid an imminent recession, but interest rates may have to rise a bit further and remain there for a while to cool the pace of economic activity.
Stock markets were reasonably resilient throughout most of February despite concerns about sticky inflation. But the expectation of prolonged, elevated interest rates took its toll a little, and some of the markets’ gains were lost towards the end of the month.
Bond markets also struggled in response to changing interest rate expectations, with government and corporate bonds giving up many of their January gains.
Meanwhile, China and other emerging markets underperformed last month, owing partly to the strength of the US dollar and its impact on the value of company profits there. The economic outlook for the region remains unchanged – uncertain – and we reduced our exposure last year because of this.
We’ve also reduced our exposure to Japanese government bonds recently. Since 2016, the Bank of Japan has implemented a yield curve control policy that has held yields artificially low. We believe steps could be taken to loosen, or even dismantle, this policy. This could push bond prices down and dent their performance.