The Fed: inflation over growth.
The Federal Reserve raised rates by 50bps and signaled the start of their balance sheet reduction from June. The Fed also signaled the likelihood of 50bp rate hikes at the next couple of meetings. During the Q&A, Chair Powell argued against the idea that the rate hikes would push the US economy into a recession stating that the labour markets are still incredibly tight and that consumers are strong. While Chair Powell downplayed the probability of a 75bp hike, overall, the meeting was still fairly hawkish given the signal of multiple 50bp hikes to come and a view that these hikes would not materially increase the risk of a recession.

The BoE: a dovish hike.
The BoE remains extremely behind the curve in terms of monetary tightening. The BoE raised interest rates to 1% but forecast inflation would reach 10% by year-end – implying that real rates are likely to remain deeply negative in the UK. In theory, the BoE should raise rates aggressively, even at the risk of further weakening the UK consumer. However, the BoE we think will continue to remain behind the curve given post Brexit challenges.

Market volatility is back.
Volatility increased across all asset classes this week as central banks stayed firm on the need to tighten policy. The volatility was especially in assets directly impacted by monetary tightening, e.g., rates and credit spreads. Rates are almost above 2018 levels and credit spreads have widened to above 2018 levels. Both asset classes have not underperformed significantly to equities and commodities since the start of the year. In our view, rates could still be wider, given US inflation is likely to remain above 5% until year end, according to our models. However, spreads are starting to look attractive at these levels. We think spreads are pricing in recession risks. While it is likely that growth will be weak due to monetary tightening, our models so far show a strong consumer that can withstand higher rates.

Algebris Investments’ Global Credit Team