Capital Group: Better outlook as Fed cuts rate hikes

2022 will not be an easy year for bond markets as the US Federal Reserve hikes interest rates sharply to curb inflation. Once the rate hikes end, many funds will wonder if volatility will end in 2023 and a period of relative calm will begin.

At its December meeting, the central bank opted for a dovish approach, raising interest rates by half a percentage point from 4.25% to 4.50%. This relatively low rate hike was good news for investors after four consecutive 0.75 basis point rate hikes by the central bank to tame inflation. But the central bank has hinted that interest rates will be raised by another 5%.

Even bigger challenges lie ahead. Such as: Inflation is high and the economy is expected to slow or contract.

Inflation may have peaked, but will remain high

Even the most optimistic investors face recession. The question is how big or how deep the decline will be as central banks around the world raise interest rates to control inflation. Are growth in major economies including the UK, European Union, Japan and the US expected to stagnate or contract in 2023?

Demand for sectors that can quickly execute interest rate hikes, such as housing, has apparently fallen. Other economic sectors take longer to cool down. “The impact of interest rate hikes will be felt in the coming months and will be reflected in higher unemployment, fewer job opportunities and a decline in retail sales,” said portfolio manager Richie Duazon.
So far, the economy has handled this surprisingly well. But ironically, these are precisely the bright spots that could exacerbate the inflation problem. “Supply chain issues appear to have resolved themselves, but tight labor markets and steady wage increases may keep inflation above the central bank’s 2% target for some time,” Tuazon said. Geopolitical risks could further undermine central bank action.

“The dilemma is lurking,” Tuazon said. The fearful combination of stagnant economic growth, high unemployment and rising prices calls for a proactive approach to investing in bonds. “I see opportunities in government bond yields and Treasury inflation-protected bonds.”

Follow Executive Finance on LinkedIn!