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interest rates

Higher, faster, together – These are words often associated with the Olympics; however, they also describe the anticipated direction of global central banks’ interest rate policies.  Key global central banks including the Federal Reserve (U.S.), Bank of England and the European Central Bank are forecasted to raise their short-term interest rates in 2022 to help place a damper on elevated inflation levels.  Regarding the Federal Reserve, expectations heading into 2022 were for 1-2+ interest rate hikes while the central bank signaled in January 2022 an expedited timeline for this year than what was initially expected.  According to institutional market research provider Goldman Sachs, their forecast is for the Federal Reserve to implement 5-7+ interest rate hikes this year starting in March 2022.

The change in rising rate expectations has contributed to the recent equity and fixed income market declines.  For the abbreviated time frame of January 2022, global equity markets declined by -4.9% (as measured by the MSCI All Country World Index) and fixed income markets declined by -2.7% (Barclays Municipal Bond Index).  We believe it is vital for long-term investors to maintain their investment fortitude despite the recent market dislocation, given that U.S. large cap equity markets since the 1980’s have incurred on average an intra-year decline of -14.0% while calendar year returns have been positive in over 75% of those calendar years (according to J.P. Morgan Asset Management).  The recent market dislocation can represent opportunities for long-minded investors to deploy accumulated cash positions at relatively lower market prices.

Also, we believe investors should consider two key asset class implications of rising interest rates.

  1.  Key global equity market implications – During periods of rising interest rates, value-oriented equity sectors can provide opportunity for favorable returns relative to growth-oriented equity sectors.  According to J.P. Morgan Asset Management, value equity sectors and regions (international equity markets tend to contain more exposure to value equity sectors versus U.S. equity markets which tend to contain more exposure to growth equity sectors) can have relatively higher correlation to U.S. Treasury yield movements.
  2. Key fixed income market implications – Typically when interest rates rise, bond prices decline. Particularly, longer maturity and low coupon bonds can contain higher relative amounts of interest rate sensitivity.  We believe employing a lower relative amount of interest rate sensitivity for one’s fixed income allocation can be prudent to help mitigate the impact of rising interest rates.

 

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Chase D. Conti, CFP®, CAIA

Senior Investment Analyst

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