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Having your cake and eating it?

You can’t have a soft landing and a Fed pivot
Steve Russell
Fund Manager

After a dismal 2022, markets are off to a flying start this year. Chinese and European equities are leading the way – the FTSE 100 is close to an all-time high and even some of the epic ‘fails’ from last year’s sell-off are enjoying a decent bounce (Bitcoin +39% and Peloton +59% so far in January).

Behind this rally is a growing belief that we could have a ‘soft landing’. That the recession so widely predicted for 2023 can be avoided or at least delayed. This could happen. Higher interest rates will take time to impact economic growth and China’s reopening is playing a big part in this newfound optimism.

But at the moment it seems as though investors are trying to have their cake and eat it. Markets want to have the cake of stronger growth, whilst also eating the cake of interest rate cuts later this year. In fact they are now forecasting interest rates to be lower in 12 months’ time than they are today.

Crucially, as this month’s chart shows, investors don’t believe what the Federal Reserve (Fed) keeps telling them.

Chairman Jerome Powell and the other Fed members are desperate to restore some of the credibility lost when inflation turned out to be not-so-transitory in 2022. Hence their repeated statements emphasising the need to avoid the mistakes of the 1970s and not loosen policy too quickly. If a recession is avoided, how quickly can the Fed, so concerned about not letting the inflation genie out of the bottle, realistically reverse course?

This looks like a case of cognitive dissonance – believing several conflicting ideas at the same time. The stronger the economy, the stickier inflation is likely to be and the less likely the Fed is to cut rates. But stockmarkets are now assuming an almost impossible trinity of events: better growth and no recession, rapidly falling inflation, and interest rate cuts by the end of the year.

We think this month’s chart represents the defining question for 2023. Who will be right, the Fed or markets? It can’t be both. You can’t have further corporate earnings strength and 2% inflation, you can’t have China reopening and low energy prices, and most obviously you can’t have a soft landing and a big Fed pivot.

Despite their strong start, markets are not out of the woods yet. Enjoy the early 2023 bounce, but the need for protection in portfolios has not disappeared. Remember that markets can be very wrong. Just a year ago they forecast only 80bps of rate rises in 2022 – we ended up with 400bps. Ruffer’s capital protection approach provided a rare safe harbour for investors last year and we think this year’s strong start for equities increases the odds of it proving just as important in 2023.

Ruffer Radio: Led by the Fed
January 2023: Of the many storylines to unfold in 2022, only one really mattered to investors – rising interest rates and falling asset prices. The chief protagonist in this tale – the Federal Reserve - conducted one of the fastest and steepest rate hiking cycles in financial history. But how much further do they need to go? Investment Manager, Fiona Ker discusses the unenviable choices facing central bankers and explains why monetary policy will continue to dominate the narrative in the next chapter in markets.
Read
Re-enter the dragon
January 2023: Jamie Dannhauser looks at the effects of China’s reopening on the global economy. If chaos does emerge in China’s labour market, it’s unlikely to be good news for asset markets. Optimists look forward to a powerful rebound in growth, but could it relight the inflationary flames?
Read
The perils of yesterday’s logic
Increasing inflation volatility represents the greatest challenge to investors for a generation. A new regime and the collapse of the financial market status quo requires us to reimagine portfolios. No longer can we rely on yesterday’s logic.
Read

Source: Refinitiv, Federal Reserve, FactSet

The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. This article does not take account of any potential investor’s investment objectives, particular needs or financial situation. This article reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. This financial promotion is issued by Ruffer LLP.  Read the full disclaimer.

our thinking
So you want stock TIPS?
November 2023: After a bond market rout commensurate with the steepest and fastest rate hiking cycle in a generation, is there now a case for adding fixed income into portfolios? Perhaps - there might even be two. In this month’s green line, Fund Manager Duncan MacInnes looks at the cyclical and structural cases for inflation-linked bonds.
It's a very, very mad world
October 2023: Some extraordinary dynamics have emerged in markets in 2023. None more startling than the breakdown of the typical relationship between bond yields and equity valuations – especially mega-cap tech stocks. So far, it’s been bond investors who have endured the pain of rising real yields. But is an equity market repricing – reflective of stickier inflation and ‘higher for longer’ rates – the shoe that’s yet to drop?
Responsible Investment Report
We outline some of the difficulties of engaging when it comes to commodity investments and explain our efforts to find ways around them. This quarter's engagements in focus are with BAT, ArcelorMittal and Perseus Mining.
Ruffer Radio: From the Chairman
July 2023: In this quarter’s episode of Ruffer Radio, Chairman Jonathan Ruffer shares his perspectives on the evolution of Ruffer’s all-weather investment approach since founding the firm in 1994. Jonathan reflects on the genesis of the firm, making mistakes, the character traits that shape his investment style, and the challenges and opportunities facing investors today. And crucially, how these are reflected in the Ruffer portfolio.
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OUR THINKING
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Edinburgh
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75008 Paris, France