It’s almost as if, all at once, the Fed has realized that policy has been left too accommodative, for too long. To their credit, if they’ve realized a mistake, they’re going to fix it—and fix it fast. Expectations are now for interest rate liftoff in March, with four hikes this year, as well as a faster-than-previous reduction in the balance sheet. This week’s inflation fully confirmed that such moves are coming, with core inflation lurching to 5.5% y/y, the fastest clip since 1991, and shorter-term metrics showing no evidence of cooling. The headline rate hit a 40-year high of 7.0% y/y.
Despite that, equities have held up very well considering the drumbeat of earlier and more aggressive monetary tightening talk. Taking a look at performance over the past month gives a pretty good snapshot of relative performance early in a tightening cycle. Energy has led the pack on both sides of the border, with double-digit gains over the past month, while materials have also outperformed. Banks have also rallied and outperformed the broad indices in both Canada and the U.S. While the yield curve has flattened somewhat, the prospect of higher interest rats is supportive of the earnings outlook.
At the other end of the spectrum, technology has lagged, with the sector down 2% over the past month in the S&P 500, and the Nasdaq underperforming the other major North American indices. Technology has almost become a sector to just ride through the entire cycle, but with valuations rich after the massive pandemic run, the concern is that tighter monetary policy will weigh on those valuations. Finally, rate-sensitive sectors such as REITs and utilities have held their ground, for two major reasons—longer-term interest rates, while backing up, have not blown up; and many names in these sectors have solid pricing and dividend-raising power in an inflationary environment.
|Table 1 - Market Performance|
|Source: BMO Economics, Bloomberg|