To recap my previous post, Fed Chair Jerome Powell announced a 0.25% rate hike last week. The Fed is monitoring the economy and has telegraphed its intention to hike rates as needed to bring down inflation in response to the sharp price increases consumers are seeing in their daily lives.
Volatility has picked up in the past few months, not only in stocks but in commodities too. European natural gas rose after Vladimir Putin announced he is preparing to demand payments in rubles. Europe has become dependent on Russia’s Natural Gas as their main source of fuel.
UK Natural Gas (FN) 12-months
In addition, we are seeing wild moves in metals and agricultural markets as a result of Russia’s invasion of Ukraine. Exchanges are increasing margin requirements thereby reducing liquidity in some markets which ultimately means a well-defined process is needed to avoid unnecessary risks. The LME’s actions in the Nickel market added to the extreme market volatility.
In fixed income, investors rushed to sell bonds following Fed Chair Powell’s hawkish statement on Monday foreshadowing the potential for a 50bps hike in rates as early as May. The Fed’s interest rate hikes have a direct correlation to moves on the front end of the U.S. Treasury yield curve. This curve is widely used as a measure of market sentiment. Normally, investors would value longer duration treasuries higher than shorter ones, due to the risk of holding them for longer periods. But when the front end of the curve rises, thereby inverting the yield curve, investors worry. A yield curve inversion would mean that investors’ view of duration risk is changed. In the past, the yield curve inversion has preceded a recession by 8 to 24 months, hence its importance and usage.
At this point, it is fair to say that the Fed’s rate hike (and possible more aggressive ones to come) is causing the short end of the curve to rise sharply. The long end of the curve remains little changed possibly due to the massive balance of 30-yr treasuries on the Fed’s balance sheet. As of now, there is a difference of less than 20 basis points between the 5-yr and 30-yr treasuries, a level not seen since 2007.
US Treasury Actives Curve (YCGT0025 Index) Last
Will stocks be a successful hedge for inflation?
Only time will tell, but volatility in the markets seems like it is here to stay. Once again, having a well-defined approach to investing across asset classes could help in reducing unnecessary risks and potentially profiting from market turmoil.