Skip to main content

Choose your location

Current selection

Netherlands
English
Canada
United States
Asia Regional
Australia
New Zealand
Austria
Belgium
Denmark
Estonia
Finland
France
Germany
Iceland
Ireland
Italy
Latvia
Lithuania
Luxembourg
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland
United Kingdom

Download

Audience for the document: Share Class: Language of the document:

Download

Share Class: Language of the document:

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the twenty four-year period ended June 30, 2020, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest

February 2022 / MARKETS & ECONOMY

There Will Be Turbulence

Why this Fed hiking cycle looks different

Well, it’s certainly been an eventful start to 2022. To slay inflation—the ultimate villain—the major central banks have now shifted into full‑blown tightening mode. Predictably, interest rates have reacted by selling off, and risk markets are on the back foot.

In the early stages of monetary tightening cycles, risk markets usually struggle at first before finding their feet. Below, I explore why this tightening cycle looks different and why I believe it will turn out to be an extraordinarily bumpy one for risk assets. Put simply: To bring inflation to its knees, central banks will need to keep risk markets off balance.

To bring inflation to its knees, central banks will need to keep risk markets off balance.

When Temporary Becomes Permanent

Only a few months ago, U.S. Federal Reserve Chair Jerome Powell described the inflation spike as “temporary” (in central bank lingo, the word temporary means a shock that does not require a monetary policy response). By the time of the January Federal Open Market Committee (FOMC) meeting, however, Powell had clearly changed his mind. With growth expected to run above potential and the labor market expected to tighten further, he made it clear that he believes the surge in inflation will exhibit some very “persistent” features.

Persistent inflation requires a policy response—in which case, Powell and his colleagues at the Fed have a real challenge on their hands. Monetary policy must be tightened to reduce the demand for labor—and we’re not talking about a “benign” tightening to anchor inflation expectations or preemptively slow the economy before it hits full capacity. No, the economy is already operating at full capacity, wage inflation is real and persistent, and the central bank is behind the curve. Seen from this angle, the Fed finds itself in a situation that it has not been in for more than a decade.

...the Fed finds itself in a situation that it has not been in for more than a decade.

In an ideal world, the Fed could tighten monetary policy and all risk markets would continue to trade well while the economy slows. But that isn’t the world we live in. In reality, the Fed must accept either a strain on the markets or an economy that continues to grow above potential. At the January press conference, Powell made it clear that it would be the former.

Financial conditions are not under direct control of the Fed, but the policy rate is a powerful lever and, if used persistently, it will move financial conditions in the direction the Fed desires. The exact nature of the tightening of financial conditions is the result of a complex interaction between growth and risk sentiment. When growth is strong, risk assets such as equities, credit, and foreign exchange tend to trade well. To drive financial conditions tighter against a backdrop of strong growth, the Fed must deliver a robust salvo of interest rate hikes. Although equity and credit markets are likely to remain resilient in such a scenario, the bond market will crack as the policy rate is driven to increasingly high levels, and eventually the dollar will strengthen.

Disruption Cannot Be Avoided

The tightening of financial conditions amid a backdrop of weak growth has a very different profile. When growth is weak, risk markets are frail. As the Fed embarks on the tightening process, financial markets switch to risk‑off mode: Equity and credit markets sell off and the dollar appreciates. In this scenario, the longer end of the yield curve remains resilient.

Regardless of the outlook for growth, if the Fed wants to slow the economy (for example, to reduce the demand for labor), it must pull the policy rate lever until financial conditions tighten. If my analysis is correct, the near‑term outlook for risky assets is murky because any resilience they show will merely be met by another salvo of rate hikes. In short: The Fed is on a mission to keep risk sentiment weak.

Most monetary tightening cycles are not like this. During normal cycles, the Fed preemptively tightens well before the economy is at full capacity. Risk assets struggle initially but then settle—it is only toward the tail end of the cycle that we experience more serious market corrections. I think this cycle is different because the Fed believes it has fallen behind the curve because the labor market is already too tight and the economy is already growing too rapidly. This is why I expect this tightening cycle to be of the more disruptive, risk‑off kind.

Don’t Be a Hero

For investors, this is no time to be a hero. Financial markets are likely to be choppy and trade with a risk‑off bias. Eventually, this will offer opportunities for astute investors with the capacity to add risk assets to their portfolios during periods of market weakness. The sell‑off in rates has been fast and furious, but if my expectation for the near‑term growth trajectory transpires, the rate sell‑off is already mature and we are likely to see some respite from the long end of the yield curve. Fed hawkishness will keep the front end of the yield curve anchored, and consequently, rallies in the long end of the curve will cause the yield curve to flatten. In line with historical experience, a risk‑off environment is a boon for additional dollar strength.

At this point, you might complain: “But if growth slows, surely central banks will just make a U‑turn?” Maybe. But the key point in my analysis is that Powell believes that the Fed has fallen behind the curve, which will make a FOMC U‑turn very difficult. Let’s not underestimate Powell’s resolve: In 2018, he hiked policy rates consistently even while unemployment rose. If the preeminent central banker of the world has decided that the labor market is tight and demand for labor must be cooled off, financial conditions will tighten.

There are no two ways about it, I’m afraid.

IMPORTANT INFORMATION

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Previous Article

February 2022 / INVESTMENT INSIGHTS

Rethinking Fixed Income Allocations
Next Article

February 2022 / INVESTMENT INSIGHTS

Restored Supply Chains Should Propel a Eurozone Recovery
202202‑2035567

February 2022 / INVESTMENT INSIGHTS

What’s Behind the Market Volatility, and What We’re Watching Next

What’s Behind the Market Volatility, and What We’re Watching Next

What’s Behind the Market Volatility, and...

Further price fluctuations loom amid Fed hikes, inflation, and post-pandemic shifts.

By Sébastien Page, Justin Thomson & Mark J. Vaselkiv

By Sébastien Page, Justin Thomson & Mark J. Vaselkiv

You are now leaving the T. Rowe Price website

T. Rowe Price is not responsible for the content of third party websites, including any performance data contained within them. Past performance is not a reliable indicator of future performance.