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Client update - 12th May 2023

The Bank of England raised rates by the expected 0.25% yesterday, with a 7-2 vote in favour of the rise, taking interest rates to their highest level (4.5%) since 2008 and also provided the biggest upward revision to GDP in its history as it now expects the UK to avoid a recession. The Bank set out its expectation that by mid-2026, GDP will be 2.25% higher that it had predicted back in February. The Bank also warned that inflation would take longer to hit its 2% target, instead it expected 4th quarter inflation to be 5.1% (instead of previous 3.9% guide) and would not be at 2% until the start of 2025. This is quite a change and was focused on stubborn food inflation.

On the other side of the pond, the US Federal Reserve (Fed) tightening cycle has come a long way in just over a year with interest rates having risen 5%, the Fed has shed $400bn in assets and, more recently, a string of bank failures has started to constrict credit. Headline inflation is coming down, with core inflation (taking out energy and food) remaining a little more stubborn, although jobless claims in the US are starting to rise. It does feel like the time is right for a pause in US interest rate rises before focus turns back to the Bank of England and the European Central Bank.

The US consumer price index rose by a below forecast 4.9% from a year earlier, the first sub-5% reading in two years. Whether the recent rate rise by the Fed caps off the most aggressive tightening cycle in four decades is still being debated. The CME FedWatch Tool — which tracks the probabilities of rate changes — indicates that investors believe that there is about a 95% likelihood of no change to rates at the 14th June Federal Open Market Committee meeting.

You are probably thinking “what normally happens when the Fed stops raising interest rates”? The sample size is actually surprisingly small, with only 14 main rate rise cycles since the S&P 500’s inception in 1928. That suggests caution around thinking there is a consistent pattern to apply to investment decision making and this is indeed the case with an extraordinarily wide range of outcomes in the 14 cycles, the subsequent market returns fluctuating by almost 60%.

There is not much of a pattern between the date of the final rise and the S&P 500 performance at the six-month and one-year point. Likewise, the span between the final rise and the subsequent first rate cut varies from 58 days later in 1957 to 874 days later in 1981. This highlights that there are always myriad influences on market behaviour — not just monetary policy. This rate rise cycle has already been particularly unique relative to the past three cycles. Last year, stocks suffered during the first six months of the rise cycle; in contrast to the previous three main rise cycles (2015-2018, 2004-2006, and 1999-2000), when stocks rallied during the rising phases. In this anything-but-typical cycle, be wary of “typical” commentary when it comes to market behaviour and we are certainly keeping a watchful eye.

I am often heard referring to the old chicken and egg situation, where two things are so necessary to one another, it is impossible to work out which one came first. I do, however, know which one has suffered more from inflation in the last year. According to the latest Bureau of Labour Statistics report, egg prices in the US were 36% higher in March compared to the same period last year, while the cost of a fresh whole chicken was only up 8.9%. However, month-on-month (and seasonally-adjusted) the price of an egg collapsed 10.9% in the month of March, an eggceptional collapse. Good news for my breakfast. Do have a good weekend.

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