Only a couple of weeks ago, investors thought they had 2023 mapped out.
After a torrid 2022, during which New York’s all-conquering Nasdaq tech index crashed and lost a third of its value, this year looked a lot brighter.
Markets were anticipating the moment when the US Federal Reserve would start cutting interest rates rather than hiking them, at which point share prices would fly.
It all seemed to be coming together in early February, when US Federal Reserve chair Jerome Powell said that the “disinflationary process … has begun”.
Watch: US Federal Reserve chief warns of 'pain' in reducing inflation
Such was the initial joy that many chose to overlook his proviso that the process still “has a long way to go”.
Instead, investors started jostling for position ahead of the so-called Fed “pivot”, hoping to be first out of the blocks.
Then it all went wrong. Suddenly, 2023 didn’t appear as clear cut. Last week, Mr Powell turned more hawkish, noting that economic data had “come in stronger than expected” since he last spoke.
He then added the chilling warning that “the ultimate level of interest rates is likely to be higher than previously anticipated”.
Panic ensued. Equities, Bitcoin and gold gave up their gains, while bond yields soared.
James Bentley, director of Financial Markets Online, says the shock was palpable. “Mr Powell didn’t just say the door to further big rate hikes was open, he gave the impression he was ready to march through it.”
The Fed funds rate currently ranges from 4.5 per cent to 4.75 per cent, with markets anticipating a modest 0.25 per cent hike at its next meeting on March 22.
After Mr Powell’s shift, they were pricing in a 70 per cent chance of a 50 basis rate increase to 5.25 per cent, according to the CME FedWatch tool.
Investors were also shaken by January's non-farm payroll figures, which show the booming US economy created 517,000 new jobs in a month, putting greater pressure on Mr Powell to raise rates to prevent an inflationary wage-price spiral.
Suddenly, there was talk of interest rates peaking at an unthinkable 6 per cent instead, a figure that would crush the life out of the global economy.
While Goldman Sachs analysts are uncertain about a rate rise this month after the collapse of Silicon Valley Bank, US interest rates at 6 per cent remains a possibility as the Fed gets aggressive with inflation, says Vijay Valecha, chief investment officer at Century Financial.
“That would be the highest rate in more than 20 years and put a big dent in corporate profits. If it happens, markets are heading for a hard landing.”
Higher interest rates would also drive the US dollar to fresh highs as investors flee to the world’s number one safe-haven asset class, further depressing demand for crypto and gold, which are denominated in dollars and would become more expensive for buyers in other currencies.
A stronger greenback will also hit emerging markets, which have borrowed heavily in dollars and will pay more to service their debts, Mr Valecha says.
Investors had grown too complacent about the Fed pivot, says Jason Hollands, managing director at investment fund platform Bestinvest.
“While US inflation has been in retreat in recent months, it was still 6.4 per cent in January, far above the Fed’s target rate of 2 per cent. Core inflation is particularly sticky.”
Higher inflation for longer is bad news because it drives up borrowing costs for businesses and consumers. “Businesses with highly leveraged balanced sheets are now staring at much higher refinancing costs, while inflation shrinks the value of future cash flows in real terms,” Mr Hollands says.
It will also drive bond yields even higher, “putting them back on the map for investors who ignored them for years”, Mr Hollands says.
This is bad for shares as investors can get competitive yields on bonds but with less risk to their capital. It’s even worse for Bitcoin and gold, as neither pay any interest. Bitcoin has fallen below $20,000, and the gold price has lost its shine, too.
Investors had shifted from joyful optimism to grim pessimism within a matter of days — and then things got really confusing.
On Friday, February’s US non-farm payrolls showed another 311,000 jobs were created in February, more than the 205,000 forecast, beating expectations for the 10th consecutive month.
Yet, this was well below January’s figure and there were some worrying numbers, with unemployment up to 3.6 per cent against a forecast of 3.4 per cent, wage rises slowing and hours worked falling.
This is not the behaviour of an impregnable jobs market, Mr Bentley says. “The revelation that America’s jobs market is more fragile than previously thought will make the Fed's next steps more tentative.”
If the Fed continues its rate hikes, more problems might surface as people struggle to service their debts, says Fawad Razaqzada, market analyst at City Index and Forex.com. “Those concerns may intensify if the Fed opts for a 50 basis point rate hike this month.”
Markets are now turning their attention to Tuesday’s consumer price inflation announcement for February, with retail sales data to follow the following day.
The data will decide what the Fed does next, but now there is another worry to add to the mix, Mr Razaqzada says.
On Friday, US banking stocks went into meltdown after Silicon Valley Bank was seized by US regulators.
“Silicon Valley Bank’s shares plunged as it announced plans to shore up its finances, while Silvergate Capital collapsed amid the crypto turmoil,” Mr Razaqzada adds.
Global financial stocks fell on contagion fears, amid mutterings that we are seeing a repeat of the 2008 banking crisis. However, US regulators at the weekend stepped in to say that Silicon Valley Bank customers would have access to their funds from Monday, Reuters reported.
Inflation around the world — in pictures
This only intensifies Mr Powell’s dilemma, Mr Razaqzada says. “If he opts for more hikes, there is a risk that some regional banks might collapse, while not doing anything could exacerbate inflationary pressures.”
There is no easy answer. “Judging by Friday’s reaction, the market feels like whatever the Fed does, the economy is going to take a hit.”
Naturally, European and UK shares also crashed on Friday because where the US leads, the world is forced to follow.
Chris Beauchamp, chief market analyst at online trading platform IG, predicts more turmoil to come. “The avalanche of selling looks unlikely to end soon.”
He says interest rate expectations have gone on a “round-trip” in the space of a single week.
“Volatility is on the up and next week’s consumer price inflation figure means that investors can’t sleep easy just yet.”
So what happens next? Nobody knows. As this year has already shown us, second-guessing the future is not possible and often downright dangerous.
Everything now depends on the data — and that's all over the place.
For private investors, the advice doesn't change. Leave your money in the market, as history shows share prices climb over time.
And take advantage of any dips to buy more shares. You probably won’t have long to wait.