The behavior of the markets is one of the most relevant issues in the global economy in 2023. Even more so in the global context of tense calm after the banking crisis that originated in the United States last March. It is well known that the prices of financial assets fluctuate constantly, and that these fluctuations have a significant impact on the real economy. One of the reasons for this volatility is due to the relationship between asset prices and monetary policy.
The last 18 months have seen an accelerated interest rate hike cycle in some major economies, such as the US. As rates have been rising, so have the prices of financial assets, such as stocks and bonds. However, in the final stage of this cycle, an interesting phenomenon has been observed: the noise generated in the financial markets.
This distortion or noise would refer, according to experts, to fluctuations in asset prices that are not justified by economic fundamentals. In other words, the noise is the result of market speculation and emotions, not actual economic data. “This speculation can be fueled by any number of factors, such as political uncertainty or the lack of clear information about the movements of central banks,” says Morgan Stanley in a recent note.
In this context, it is interesting to explore why market noise tends to increase at the end of a cycle of interest rate hikes. Florian Späte, Senior Bond Strategist at Generali Investments, notes that “in the late cycle, investors become more concerned about the potential risks that rising rates could pose to markets, and they begin to speculate more about the duration of this cycle and about the next recession”.
In other words, investors become more fearful as the end of the cycle approaches, and this translates into higher volatility and price fluctuations that are not justified by economic fundamentals. In addition, the lack of clear information from central banks also about their future policies contributes to noise in the markets.
To understand why stock price developments tend to generate noise in the final rate hike cycle, it is important to consider the interconnectedness of markets and how economic decisions emerge for investors. According to Philipp Vorndran, chief strategist at Flossbach von Storch, “investors are concerned about the impact that rate hikes may have on economic growth, inflation and therefore corporate profits.” In this context, any news or event that affects the economy, such as a rise in interest rates, can generate uncertainty in the markets.
Another factor to consider is the speculation of investors around the decisions of central banks. As Albert Edwards, chief strategist at Société Générale, puts it, “Markets have been speculating on rate hikes for so long that now any news, good or bad, can have a significant impact on asset prices.”
Caution with bonuses
In this way, investor speculation can amplify market volatility and generate noise in the final rate hike cycle. Späte expresses his opinion on the current economic situation and how this is affecting the bond market in Europe. According to Späte, “the economic situation in Europe remains fragile and vulnerable to external events, which has led to a persistent lack of demand in the bond markets.”
This lack of demand has led to bond yields in Europe remaining low, even for corporate bonds, which in theory bonds will offer a higher return due to the higher risk involved compared to government bonds. . “The search for yield has led many investors to turn to corporate bonds, but even these bonds offer low yields due to a lack of demand,” says Späte.
This situation has led many investors to look for alternatives to bonds in order to obtain adequate returns. “Investors are looking at alternatives, such as emerging market bonds or equities, in search of higher returns,” explains Späte. However, these alternatives also carry risks, which may make investors more cautious when investing in them.
In this context, Späte emphasizes the importance of portfolio diversification. “It is important for investors to diversify their portfolios, not only in terms of assets, but also in terms of geographic regions and sectors. This can help reduce risk and achieve adequate returns in a difficult market environment,” Späte stresses.
In conclusion, noise in financial markets is an interesting phenomenon that occurs in the final stage of interest rate hike cycles. “While it is difficult to predict when a recession will strike, it is important that investors keep a long-term perspective and avoid being carried away by speculation and market emotions,” Späte concludes the analysis.