Weekly Brief: Your Portfolio Is Going To Be Sore After All These Rate Hikes

Weekly Brief: Your Portfolio Is Going To Be Sore After All These Rate Hikes

almost 2 years ago3 mins

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Both the Federal Reserve (the Fed) and the Bank of England (BoE) hiked rates again this week, as central banks all over the world realize they can’t ignore the rocky path ahead of them.

🕰 Recap

  • The Fed delivered the biggest interest rate increase in over two decades on Wednesday
  • It also stamped out speculation that it was weighing up even bigger rate hikes in the next few months, temporarily sending stocks rallying
  • A day later, the BoE raised the UK interest rate to its highest level in over a decade

✍️ Connecting The Dots

After admitting in March that it should’ve acted sooner, the Fed raised interest rates by 0.5 percentage points on Wednesday – the biggest hike since 2000. The central bank said it would keep increasing rates at that pace over the next couple of meetings, but shot down speculation that it was thinking about even bigger rate hikes of 0.75 percentage points in the months ahead – much to investors’ relief. It also announced that it’ll start reducing some of its $9 trillion worth of bond holdings using a process known as “roll-off” – i.e. not buying new bonds when the ones it owns mature – at an eventual monthly rate of $95 billion. At that pace, the Fed’s balance sheet will approach its pre-pandemic size by 2024.

A day later, the BoE raised its own interest rate from 0.75% to 1% – the highest level since early 2009. In renewed forecasts, the central bank said it sees inflation climbing above 10% in October, when the cap on gas and electricity costs rises another 40%. That says a lot about how much the BoE had underestimated the country’s inflation spike: less than half a year ago, it forecasted inflation would peak at 5% in April.

The BoE isn’t as confident as the Fed that it can engineer a soft landing – that is, bring inflation down without significantly disrupting economic growth. In fact, it warned that the UK economy will slide into recession later this year, as higher inflation and interest rates squeeze household finances and consumer spending – the biggest driver of the country’s economy.

🥡 Takeaways

1. The Fed isn’t alone in reducing its bond holdings.

The BoE has already started to reduce its balance sheet by ending bond reinvestments in February, while the Bank of Canada’s roll-off is expected to see its holdings of government debt shrink by 40% over the next two years. In fact, Bloomberg Economics is estimating that central banks in the Group of Seven countries will shrink their balance sheets by about $410 billion in the remainder of 2022 – a stark turnaround from last year, when they added $2.8 trillion. This coordinated “quantitative tightening” – the opposite of quantitative easing – will only introduce yet another shock to the world’s economies and financial markets…

2. The Fed’s actions are causing US government bond yields to soar.

Higher inflation, rising interest rates, and the anticipation of quantitative tightening have all pushed the 10-year Treasury yield above 3% for the first time in more than three years this week – more than double its level at the start of the year. That has important implications for the economy: Treasury yields impact mortgage rates, company borrowing costs, the appeal of riskier investments, and more.

🎯 Also On Our Radar

Vacation rental marketplace Airbnb reported first-quarter sales and gave a revenue forecast for the current quarter that both topped analysts’ estimates. The company sees “substantial demand” for travel heading into the busy summer season, after more than two years of Covid restrictions. That’s the same message investors got from peers Expedia and Booking Holdings, both of whom have said they expect this summer to be one of the best the industry has ever seen.

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