Key points
- The volatile start to the year in financial markets is set to continue for a while yet.
- Fed hikes, surging inflation, a post‑pandemic repricing in stock markets, the Chinese economy, and the Ukraine‑Russia border dispute have the potential to disrupt markets.
- Steering a course through this environment will be very challenging, but market volatility and sector rotation should present good opportunities for active investors.
The volatile start to the year in financial markets is unlikely to abate soon. Sustained inflation, a looming Federal Reserve (Fed) rate‑hiking cycle, tightening liquidity conditions, and the unwinding of pandemic‑era economic distortions—among other factors—mean that further price fluctuations can be expected.
The Forces Driving Markets This Year
Five key developments to monitor
Although it is too early to say that we are entering a post‑COVID world, it is clear that the pandemic is no longer the dominant driver of markets that it has been. The new environment will be difficult to navigate—but it will also provide some excellent opportunities for stock pickers.
Fed Hikes Alone Tend Not to Derail Markets
Anxiety over Fed rate hikes was the primary cause of recent volatility. For most of last year, the Fed maintained a dovish stance, focusing more on reducing unemployment than curbing inflation. Then, in its December monetary policy meeting, it made it clear that rates would soon be rising. This prompted the markets to immediately price in rapid policy tightening, hence the declines in financial markets during January.
Markets initially responded positively to the Fed's January statement, which confirmed March as the target for a rate hike. However, comments from Fed Chair Jerome Powell at the subsequent press conference changed the mood dramatically. "I think there's quite a bit of room to raise interest rates without threatening the labor market," said Powell—implying that the Fed may adopt a more aggressive hiking cycle than expected. Markets, which had been pricing in four hikes in 2022, suddenly had to price in more—sparking another bout of volatility.
This post was funded by T. Rowe Price
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