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Last week’s Federal Reserve (Fed) statement might have caught investors’ by surprise. However we believe one has to read thoroughly through both the official statement and the press conference thereafter to understand the Fed’s communicative intentions.
The Fed changed to 2023 its interest rate projections, while in the press conference the Fed’s chairman maintained a relatively dovish tone and stated that despite the change in its interest rate projections a lot can change ad interim.
The surprise namely came about through the Federal Open Market Committee’s (FOMC), as the survey, better known as the DOTs survey showed a rise in overnight lending rates from 0.125 percent to 0.625 percent, thus implying two rate hikes in 2025 of 25bsp each. We believe that this revision was not only conditioned by the better than expected inflation data, but rather a smart move by the Fed following the stability we’ve experienced in the 10-year U.S. Treasury over the past days prior to Wednesday’s meeting. Indeed, in late March we’ve seen the yield spiking to circa 1.769 levels, as investors’ expectations in regard inflation resurged. We think that the Fed rationally opted in raising its inflationary forecasts to cover its position with markets and mitigate as much as possible market shocks going forward. Nevertheless, it is clear that the Fed continues to be very data dependent and thus the moves we’ve seen in late first quarter might have been too optimistic by market participants.
Since the beginning of the year we’ve discussed ad nauseam that a spike in inflation is inevitable due to the base effect. In the coming quarters that would be well behind us and now the debate is whether inflation will be sustained or transitory. It is the latter that will condition the Fed’s moves going forward and we believe that we will have clearer visibility in the last quarter of the year or possibly in the first quarter of 2022. In reality, the recent surprising figures do not say much about what were the consumer trends over the past months. Rather, the figures show that inflation was predominately conditioned by supply disruptions and the lack of personnel in selective industries. That said it is important to highlight that the latter is being conditioned by the more attractive Covid employment benefits which might have discouraged workers in accepting certain positons.
Thus overall we are still navigating through uncertainties in regard of whether inflation will be transitory or sustained. Thus we continue to give the Fed the benefit of the doubt and accept the path of being patient given the fact that now more than ever being data dependent is imperative in its actions going forward.
We are of the view that over the medium to long term the inflation transitory proposition might be more plausible at this juncture when considering the very benevolent actions taken by fiscal politicians over the past months to combat the pandemic, apart from the strong monetary efforts. Ad interim we believe that inflation will continue to surprise to the upside on consumers’ confidence as we return towards normalization. Nevertheless, we believe that the pandemic might have changed the ideology of consumers and their behaviour towards consumption. Moreover, we believe that the high levels of debt by not only corporates, but also by governments will have an impact, as the latter needs to be re-paid possibly by higher taxes in the near future. Thus, we believe that both themes will affect the savings rate which might not revert to pandemic levels.
From a positioning perspective, overall in the short term within the equity space, we continue to maintain the view of looking for opportunities in value stocks. Moving forward, sensitivity to higher discount rates brought about by tightening expectations might trigger market risk. That said, theoretically speaking over the medium to long-term, higher rates assume a healthier economy and thus the value trade might be an attractive play. More rationally we continue to be mindful of possibly over valued sectors, namely specific names within the growth arena.
Undeniably given the unprecedented nature of the recession, the speed of the recovery and the influence of monetary policy, staying agile during this dynamic environment continues to be an imperative. Volatility might create benevolent opportunities.
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