Rising inflation and rate hike concerns will continue to drive market volatility

Markets have adjusted to the reality that monetary policy tightening is inevitable as investors move to protect capital gains from last year's bull run

A trader at the New York Stock Exchange. Technology stocks are being heavily sold, with the tech-heavy Nasdaq index in correction territory since falling 13 per cent from its December high. AP

“Real inflation is everywhere,” said the chief executive of US investment bank Goldman Sachs during the release of the bank’s fourth-quarter results last week.

Compensation costs jumped 33 per cent in 2021, while they rose by only 8 per cent in the previous year. But it is not only wealthy bankers who are feeling the effects. It seems people around the globe are subject to rising price pressures on a daily basis, with official inflation figures for everyday goods hitting multi-decade highs.

US consumer prices recently increased at their fastest pace in about 40 years, with the headline rate hitting 7 per cent in December. Seven of the past nine releases have come in above analyst estimates. Even when stripping out the more volatile food and energy sectors, prices still registered their sharpest pick-up since February 1991.

This kind of surging consumer price data has also been reported in Canada, the UK, Germany and Japan, with booming demand and supply-chain bottlenecks continuing to persist into 2022.

The fragile nature of the just-in-time approach to global manufacturing has been laid bare and there will, no doubt, be much ongoing discussion to dig deeper into one of the principal issues coming out of the Covid-19 pandemic.

Omicron has continued to unsettle the recovery, although there is light at the end of the tunnel. But the rotation from goods spending to services spending will be crucial in relieving some of the stress in goods prices. This is because costs are currently being driven mainly by supply issues and not excess demand.

Although many economists believe these once-in-a-generation price rises will ease in time, they still see costs elevated over the course of this year. When we have been used to annual increases in cost of living at less than 1 per cent, the shock is real.

Markets have adjusted to this new reality by quickly realising that monetary policy tightening is inevitable in 2022.

The US Federal Reserve has shifted its former “transitory” stance on inflation in double-quick time and is willing to raise interest rates earlier and faster than previously thought. Traders have now priced in four 25 basis point rate increases for this year, starting in March.

The pace of bond market moves have been astounding. Last March, Fed policymakers were still saying it would be 2024 before they would start moving interest rates higher. In June, Fed officials advanced it to 2023 and, in September, they changed it to 2022 and indicated there would only be one rate increase.

The rapid catch-up by policymakers and, more particularly, the subsequent run-up in rates have some similarities to the first quarter of last year. Then followed a steady fall into the summer months.

Could we see this scene play out again if supply-chain disruptions ease and the Omicron wave subsides? Inflation expectations have been more stable recently, with China factory prices and a US factory activity expansion, for example, increasing at a slower pace than analysts expected.

However, with emergency liquidity currently being withdrawn, highly valued, expensive parts of the market are still exposed to broad, sharp sell-offs. Technology stocks are already being heavily sold, with the tech-heavy Nasdaq index in correction territory since falling 13 per cent from its December high.

The current rotation towards value stocks is expected to continue in this environment, with volatility remaining elevated. This means active stock picking appears to be the name of the game in equity markets, with a focus on companies that can deliver dividends and buybacks.

But risks of a broader correction in equities in the first half of the year, as the policy punchbowl is finally withdrawn, loom large as investors protect capital gains from the previous bull run.

Hussein Sayed is the chief market strategist at Exinity Group