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The change in Fed language suggests it is trying to make up for lost time
Thursday 13 Jan 2022 Author: Martin Gamble

US bond markets have had a torrid start to 2022 with 10-year treasury yields moving up to 1.8%, from 1.5% at the end of the December, the highest since April 2021.

The dramatic move in rates has had violent repercussions in the stock market with a clear investor preference for economically sensitive shares, or so-called value, at the expense of growth.

The technology heavy Nasdaq 100 index has lost almost 6% so far in 2021 while the US banks are up over 10%. Collateral damage from the tech sell-off saw Kathy Wood’s ARK Innovation exchange traded fund lose around 15% of its value so far in 2021.

Technology shares are more sensitive to higher long-term interest rates which reduce the theoretical value of their earnings while bank’s margins get a lift from higher rates.

Investors should get a good steer on the outlook for bank earnings this Friday (14 Jan) when JP Morgan kicks off the quarterly earnings season.

The catalyst behind the rates turmoil appears to be the latest minutes from the federal reserve 15 December policy committee meeting (5 Jan).

The minutes left the door open for earlier interest rate rises and a faster pace of increases later this year than previously thought.

Arguably, the December non-farm payrolls data on Friday 7 January added fuel to the fire despite the headline jobs gain falling shy of expectations.

The accompanying data showed a tight labour market with unemployment falling to 3.9% against 4.1% expected and wages growing at 0.6%, higher than expected.

On 10 January investment bank Goldman Sachs said it expected four rate hikes in 2022, putting it at the hawkish end of the interest rate spectrum.

Another big test of the central bank’s resolve to slow the pace of the economy and tackle rising inflation will be Wednesday’s consumer price inflation data which at the time of writing is expected to hit an annualised rate of 7%.

The Fed has so far projected a measured approach to monetary policy and is still adding liquidity to markets through its monthly asset purchases which are expected to end in March.

But the December minutes have added uncertainty to the timeline by opening the door to earlier rates hikes and faster balance sheet reduction (known as quantitative tightening).

That uncertainty and the prospect of the Fed squeezing all its policy actions, tapering, rate hikes and balance sheet reduction, into a shorter than expected timeframe has spooked both equity and bond markets and makes 2022 look more challenging.

Meanwhile rate rises are set to continue in the UK and investment bank ING reckons there is a 50-50 chance of another hike in February.

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