Global markets had a volatile start to the year. The US stock market declined -9% recovering slightly in the last 2 days of the month, to end January -6% lower. Nearly all other major financial assets suffered negative returns.
The main catalyst was the sharp rise in US interest rates, driven by the short tenors as interest rate markets increased expectations that the US Federal Reserve will hike rates this year. The 2-year rate increased 0.43% and the 10-year increased 0.28%. In addition, geopolitical tensions over Russia and Ukraine weighed on risk sentiment.
The increase in interest rates and expectations of central bank tightening come as inflation continues to prove more persistent and above target. US inflation printed at 7%, the highest in nearly 40 years.
At their January meeting, following the very strong inflation data, the US Federal Reserve announced they will end their asset purchase programme or Quantitative Easing (QE) in March. The comments from Chair Powell were received as hawkish, indicating that the Federal Reserve will likely remove monetary stimulus sooner than originally anticipated. The market now expects the Federal Reserve to hike rates 5 times this year, beginning in March.
Locally, NZ inflation also printed at its fastest pace in 31 years at 5.9%, although this was broadly expected given inflation readings and business surveys over the preceding months. Unlike was the case in the US, the NZ interest rate market already expected the RBNZ to hike multiple times this year. Because of this, NZ rates only rose by 0.28% and 0.17% in 2-year and 10-year rates, respectively.
The NZD also declined markedly over the month, down 3.8%. The increased USD demand due to the negative global risk sentiment and increased US interest rate expectations helped push the currency to levels not seen since 2020. The arrival of the Omicron variant and its potential to disrupt economic activity also weighed on the local currency. The depreciation did help insulate the global stock moves in NZD terms.
The key focus for markets going forward is the pace of monetary tightening and how much traction the policy tightening has on consumer demand, economic growth, and inflation expectations. However, even with the removal of the extraordinary monetary stimulus, global interest rates and financial conditions remain generally accommodative and should not be cause for concern.