Markets continued to fall last week, touching the lows seen in mid-June and leading many to question whether the buy on the dip trade was finally dead. Not coincidentally, long-term bond yields also pushed through the highs seen in June, as the US Fed raised rates another 0.75% and Jerome Powell reiterated the Fed’s commitment to fighting inflation via interest rate policy. During the Q&A he was asked to comment on the inevitable policy lag whereby interest rate rises only really affect the economy after 9-18 months meaning that central bankers are almost destined to over-tighten into a weakening economy. He also reiterated that the Fed is ‘data dependent’, meaning that they will only slow down rate rises when they see evidence of inflation moderating. This ed to wild gyrations in the US stock market last Wednesday and it was another 4% down for the week, with interest rates up and tech stocks the sector down the most. ‘Old economy’ stocks also came under pressure later in the week as FedEx and Ford both issued warnings about already declining economic activity. Most other markets followed suit, albeit to a slightly lesser extent. The UK market had been more resilient but fell sharply on Friday, as the incoming UK Prime Minister Liz Truss seemed to put the UK Government’s new growth orientated fiscal policy directly at odds with the Bank of England’s ever more difficult task of taming UK inflation, beset by still rising energy costs along with the other supply side and service pressures seen in the US. Despite that, the UK market was still amongst the better performers in local currency terms, but after adding a sharp fall in the value of the Pound on Friday it was down by a similar amount.

Commodity markets also reflected slowing growth expectations and were mostly in the red last week, although Australia’s miners escaped much of the pain, bolstered by strong cashflow/balance sheets and already low expectations. That left the Australian market down just a couple of percent, although it was catching up at the time of writing.

While lower earnings estimates are just starting to weigh on equities, it is still the mechanical effects of bond rates that are pushing markets around. Last week, a host of central banks lined up with similarly hawkish policies, and long-term rates were up again around the world.US two-year rates got to 3.7% while Australian rates stayed just a fraction below 4%, but the moves were again sharpest at the shorter end and even more marked in real terms. Given heightened fears of a looming recession and, with much eventual hindsight, overtightening by central banks, inflation expectations 1-2 years from now have actually been edging down. Taken together, higher nominal rate expectations and low inflation expectations means even higher real rates and a greater tightening effect on the economy. So, while some have been pleasantly surprised with how well the economy has coped with interest rates reaching levels not seen since before the GFC, the level of real rates has just surged in the last two weeks past where they got to in December2018, the last time something ‘broke’ in the global financial plumbing. That time we saw the ‘Powell Pivot’ as the Federal Reserve abruptly halted its tightening program and flooded the world with liquidity in 2019. Credit spreads also eased out again last week, again to levels last seen in late 2018. If inflation pressures start to moderate soon this will probably look like a buying opportunity in credit and equity markets but if not, markets will be wondering what might ‘break’ this time and whether another ‘Powell Pivot’ might be off the cards.