Yesterday the Federal Reserve voted unanimously to raise rates and the market expects a further hike before the year end. This will no doubt displease the President who has made it clear that he feels interest rates should be lower.

Happily for Fed Chairman Warsh, he is not in charge of the Turkish Central Bank. And while the President may feel the Fed has got it wrong, the rest of the market doesn’t. Or at least the rest of the market expected the 0.25% hike.

Why the Federal Reserve Rebuffed the President

Well, the decision to go to war in Iran and the continued disruption to global energy supplies has not helped. Neither has the re-emergence of trade tensions with Canada, the US’s largest trading partner. Both have made it harder for inflation to fall back to its 2% target.

But also the US economy is holding up well. Employment figures appear solid and the latest earnings season was strong, even for those companies not involved in the manufacture of memory chips or building data centres.

And finally, because the market expected Chairman Warsh to stamp his authority and show he was not there to do Trump’s bidding. Four of the last five Fed Chairs hiked within two months of assuming the post. Warsh has taken four.

However, the Federal Reserve also needed to demonstrate to the market that it is in control.

Rising Bond Yields Reflect Inflation Concerns

Bond yields have been rising in the US for the past couple of months as the market priced in the expected hike. To have not raised rates at this juncture may have caused those yields to push even higher, with the opposite effect on bond prices.

Weakness in the bond market has not been restricted to the US. In Europe, Japan and the UK, we have seen significant moves in the bond markets, all primarily due to the level of inflation in those countries, largely thanks to the impact of the Iran conflict. Perhaps it is also a result of the vast bond issuance by the hyperscalers to finance their ever greater spending on the AI race, and in doing so have crowded out government bonds.

And yet, equity markets have been calm.

Equity Markets Carry on Regardless...For Now

Much of that is due to the resilience of corporate earnings, as already mentioned. We are certainly seeing volatility within the AI trade, not least due to the scale of financing that it is taking place. And considering where valuations have reached in some companies, we could see more.

But while everyone’s attention is on catastrophising on whether AI will end humanity or not, other parts of the market and the economy carry on regardless.

Furthermore, where we are with inflation at around 3% and interest rates around 4% is preferable to the post-GFC era of low inflation and near-zero interest rates. Notwithstanding the indebtedness of governments around the world, especially the US, and the continued upside risk to inflation.

So, we remain watchful. Tenax remains well-diversified in its equity exposure and has maintained its stance in fixed interest that it does not pay to reach for higher yields at longer maturities because of the risk of the capital losses we have recently seen.

The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.