Central banks in the UK and the US have finally taken action to curb the surge in inflation.
Last week, the Federal Reserve said it would end its policy of quantitative easing in March next year, with a majority of members expecting three interest rate hikes by the end of 2022.
That would probably mean going from near-zero at present to 0.90%, then 1.6% in 2023, as reported by Reuters, and 2.1% in 2024.
Figure interest rates could reach by 2024
The US consumer price index, which measures the cost of a wide-ranging basket of goods and services, rose 0.8% in November, up 6.8% on a year over year basis and marking the fastest annual increase since June 1982.
Nearing full employment is another reason the Fed is likely, despite the potential risk of the new Omicron COVID-19 variant, take its foot off the economic support pedal.
"The economy no longer needs increasing amounts of policy support," Fed Chair Jerome Powell said, as reported by Reuters.
The Fed is expecting a ‘soft landing’ next year as inflation eases, interest rates rise slowly and the unemployment rate is predicted to stay around a low of 3.5% for three years. Fed officials projected US economic growth of 4% next year, an increase over the 3.8% forecast in September.
UK prices rise
In the UK, the Consumer Price Index rose 5.1% year-over-year in November, the highest level since 2011 off the back of higher energy, petrol and clothing costs as supply chain woes and Brexit hangovers hit. That is well above the Bank of England’s 2% target.
As a result, the Bank’s Monetary Policy Committee decided to hike interest rates for the first time in three years on Thursday from the historic low of 0.1% to 0.25%.
“Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022. CPI inflation is still expected to fall back in the second half of next year,” the Bank said.
“Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022. CPI inflation is still expected to fall back in the second half of next year” - Bank of England
The markets react
Overall markets have reacted well to the somewhat surprising move from the BoE and the new hawkish attitude of the Fed.
The FTSE 100 rose slightly to 7,269.92p on Friday but appeared to negate gains on Monday as fears of COVID-19 related shutdowns reverberated again. Since the Fed’s statements, the S&P 500 had also risen slightly from $4,634 on the morning of 15 December to $4,668.87 by 17 December’s market close.
Nine of the 11 major S&P 500 sector indexes climbed, with economy-focused financials, energy and materials and banks leading gains. However, tech and consumer discretionary with mega-cap growth stocks declined.
"It's a rotation toward more economically sensitive parts of the market ... and we're seeing interest rates pick up a little bit, that tends to work against technology stocks," Paul Nolte, portfolio manager at Kingsview Asset Management told Reuters.
Tech stocks remain tough
Danni Hewson, AJ Bell financial analyst, also sees tough times for tech. “Seeing a rate rise actually happen seems to have spooked the tech heavy Nasdaq. Technology has been the biggest faller, growth stocks suddenly looking less attractive as the mood shifts,” she said.
However UK banks were one of the day’s big winners. They all stand to benefit from extra income from loans and mortgage payments, but at the other end of the spectrum real estate saw the biggest losses along with utilities that have big debts that get bigger as interest rates rise.
AJ Bell’s investment director Russ Mould however doesn’t see a huge impact on US stocks from the Fed’s new direction.
“Even three rate rises in 2022 would only take the upper band of the target range to 1% - that does not look particularly fearsome in the context of the IMF’s forecast for 5% GDP growth in the USA in 2022.” This would be equivalent to a 20% annual rise in house prices.
Private equity firm KKR, according to Bloomberg, is also relatively bullish despite predicting inflation will reach 5% next year compared with the consensus 3.6%. It has boosted its 2022 target for the S&P 500 to 4,900 from 4,650, assuming earnings per share growth of 15%.
“We do not see financial conditions tightening enough in 2022 to permanently offset the extreme amount of absolute liquidity that is still in the system,” it said.
KKR sees opportunities in energy, European banks, Chinese technology companies and beaten-down conglomerates. Yet, a recent US growth estimate cut by Goldman Sachs casts a shadow on this optimistic outlook. The New Year promises to be a mixed bag.