Rising interest rates cycle: Global markets brace for impact

Federal Reserve Chair Jerome Powell asserted the central bank’s resolve to bring down inflation in overheated US economy and mentioned that aggressive rate hikes are possible as soon as next month, with 50 basis points hike on the table for the May meeting while adding that it’s absolutely essential to restore price stability.

Rate sensitive tech heavy Nasdaq remains in strong bear market with 18.91% correction ytd. Dow Jones Industrial Average and S&P 500 indices have also corrected 7.58% and 10.94% as of 25th April 2022. Global equity markets are feeling the heat as European stocks are showing similar pattern with German benchmark DAX showing 12.47% correction, French CAC 9.95% downside ytd. Chinese stocks have melted considerably with Shanghai SSE Composite down nearly 20% and Shenzhen SZSE Component losing almost one third of its value ytd. In Asia, Indian benchmark indices BSE Sensex and NSE Nifty 50 have shown resilience with around 4% correction ytd and continues to trade at premium with other emerging market peers.

Bond yields are also surging at a faster pace with US 10-year Treasury approaching 3%, a level not seen since late 2018. At 2.94% it denotes a big jump from where the 10-year started the year, at around 1.6%. One consequence of rising yields is higher borrowing costs on debt, such as consumer loans and mortgages. With rising yields cash and bonds become more attractive alternatives as one gets paid more without taking on as much risk. It is also important to understand what higher yields would mean for companies’ future cash flows, when looking at investing in stocks. One way to value stocks is to project forward the level of free-cash flow the company is expected to generate at discounted rate, which is interest rate governed by Treasury yields. Discounting back to the current cash-flow level comes up with an intrinsic value for a company.

As far as historical data from past 40-50 years goes, whenever Fed has faced the ongoing storm of rising inflation in heated economy, it has never been able to engineer a soft landing i.e. bringing down the inflation to comfortable levels without breaking the economy (causing a recession). Therefore it remains unknown as to how much tightening can the markets withstand and at what funds rate Federal Reserve will stop the ongoing hiking cycle.

Last updated on January 31st, 2023 at 08:03 am