By J.P. Morgan Asset Management | Dec. 1, 2022
David Lebovitz, Global Market Strategist | Originally published Sept. 16, 2022
In this article, David Lebovitz, Global Market Strategist at J.P. Morgan Asset Management talks about what’s been driving the on-going equity market volatility. He outlines how equity volatility is tied to the uncertainty of inflation and interest rates. These have been subject of questions and persistent speculation this year. In turn, equity volatility has remained high. Read on for Lebovitz's outlook on inflation and interest rate levels through the end of 2022 and what it means for equities.
Risk assets were better behaved in the aftermath of the Federal Reserve (Fed) meeting in July, and also coming out of Labour Day weekend. However, both of these rallies proved to be false dawns. In July, investors were under the impression that the Fed would pivot and cut rates in 2023. More recently, investors had latched on to the idea that inflation was cooling faster than expected. In each instance expectations were divorced from reality, with tougher Fed rhetoric and an August Consumer Price Index (CPI) report that showed less cooling than expected, forcing a repricing across capital markets.
Higher volatility represents a wider distribution of outcomes. Given the many questions around the outlook for inflation and rates, it shouldn’t be surprising that volatility has increased. Equity market volatility is sitting just above its long-run average while interest rate and foreign exchange (FX) volatility have remained nearly two standard deviations above their respective long-run averages.1 Looking ahead, it seems unlikely that equity volatility will be able to sustainably decline until interest rate volatility has returned to more normal levels. It’s nearly impossible to price a financial asset if you can’t decide what the discount rate is supposed to be.
We still believe headline inflation has peaked on a year-over-year basis. But, more clarity on the trajectory of inflation will be key in order for interest rate volatility – and therefore capital market volatility, broadly – to decline. The Fed looks set to continue raising interest rates in a fairly aggressive way through the end of 2022. They may continue into 2023, if inflation proves stickier than expected.
Housing inflation in particular looks set to remain stubborn. A key question will be whether the Fed is able to differentiate between the stickiness in core inflation that’s coming from housing versus consumer prices more broadly.
The bottom line is that volatility looks set to persist into year-end, and we could well retest the lows seen in June. That said, it’s important to remember that volatility creates opportunity for long-term investors.
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