Rates getting real

September was a rough month for global investors with bonds and equities selling off. On the one hand, this is not unusual as September returns are on average negative for global equities.

It is not clear why this is, nor is it a good enough reason to trade in and out of the market (as the old aphorism “sell in May and go away” would suggest). Bonds, however, do not normally fall in September and typically rally when stocks are under pressure. This time, however, there is a clear reason for the weakness across both asset classes. The common factor is that global markets seem to have finally come round to the higher-for-longer interest rate view that I’ve written about here for some time.

As per usual, it is US economic and policy developments and associated market response that set the tone for the rest of the world. The Federal Reserve kept rates unchanged at its September meeting as widely expected, but its projections for the next year or two is what caused the big moves. Every quarter, Fed officials anonymously provide their individual forecasts of growth, unemployment, inflation and interest rates, and these are summarised on the so-called dot plot. And while these forecasts must be taken with a pinch of salt since we don’t know how much conviction each official attaches to their projection, they are still instructive. As summarised in Chart 1, the September dot plot showed an improved growth and unemployment outlook while the inflation outlook still shows a gradual decline. This is all good news and means the good people at the Fed view a soft landing as more probable. But it also made it clear that interest rates will remain elevated for longer and even rise a little bit more from current levels (though that is unlikely).

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