- U.S. equities have their worst January since the 2008 Financial Crisis
- Market reaction to just the prospect of rate hikes has seen stocks heavily battered and may shake policymakers looking to get aggressive with tightening to review all the economic circumstances carefully before committing to a course of action
The U.S. Federal Reserve is taking notice.
Since suffering the worst January on record since the 2008 Financial Crisis, U.S. Federal Reserve policymakers have softened their language on policy tightening, as a repeat of 2015’s “taper tantrum” starts to rear its ugly head.
The benchmark S&P 500 index fell 5.3% in January, its biggest monthly decline since the onset of the coronavirus pandemic in March 2020 and the worst January since markets plumbed the depths of the global financial crisis in 2009.
And all that is despite the option for the U.S. Federal Reserve to reverse tapering asset purchases and raising interest rates.
If not for the last two days of January helping to regain some ground, the past month would have been the worst on record for the S&P 500.
The prospect of higher interest rates has roiled markets, with investors already skeptical about valuations.
Higher rates reduce the value that investors place on future earnings (because why bet on tomorrow when you can have your returns now), hitting the prices of companies which are promising long-term growth, at the expense of immediate gratification.
Call it the market’s marshmallow test if you will, where preschoolers are promised one marshmallow immediately if they eat it now, but two if they are willing to wait for twenty minutes – researchers found that those willing to delay that gratification generally tend to do better in life.
Nonetheless, considering that most institutional investors need to report their returns in the present, the prospect of a non-zero real rate of return from soaring Treasury yields because of increased borrowing costs is causing many to eat the marshmallow now, rather than wait for the promise of high-growth tech firms to deliver on their aspirations.
Compounding the ambiguity for investors, the threat of over a hundred thousand Russian troops on the border with Ukraine is throwing a spanner in the works for investors already having to weigh the prospect of higher interest rates and slowing earnings growth.
While U.S. companies have so far reported stellar fourth-quarter results, earnings are expected to slow after last year, when they were boosted by a comparison with a weak pandemic 2020.
Geopolitical risks from a potential Russian invasion of Ukraine are also difficult to price in, because even without a war, a prolonged standoff including sanctions on Russia, could push up global energy prices at a time when economies are already struggling to tame inflation.
Increases in the price of oil could affect consumer sentiment and distort the full inflation picture even more than supply chain snarls.
The good news is that the Fed is already starting to take notice of the complex backdrop against which it will need to set policy – preferring to preserve its “nimbleness” to respond according to an increasingly dynamic situation.
