Sudden Shift: Vanguard’s Active Fixed Income Insight

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Just a few weeks ago, the question of how much further the Federal Reserve (Fed) and other central banks would have to raise interest rates to tame inflation was on everyone’s lips. At that time, the economy seemed to be on track for expansion despite the big swings in the markets throughout the year.

Then, seemingly overnight, the outlook changed. Inflation reared its head. Wages surged to unexpected heights, and commodity prices likewise skyrocketed. Suddenly, central banks reached the conclusion they’d gone too far in curbing inflation, and began a much-needed effort to reverse their policies.

The effects of this shift reached far and wide. Governments and corporations saw their equity prices rise by the day, and risk premiums dropped as investors sought the bigger returns available in the stock market. On the other side of the equation, those who were affected by the tightening of lending conditions, such as house buyers and business owners, began to feel the pinch.

The reversal of the Fed’s policy has also helped to support a revival in economic growth. Consumer and business spending, bolstered by the pickup in asset prices and lower borrowing costs, has been on the rise. Both durable and non-durable goods saw gains from their earlier stagnation, and the labor market has also seen a considerable improvement in recent weeks.

But it isn’t all good news. The newfound surge in economic growth has brought with it the dreaded return of inflationary pressures, which could be pushed even further in the coming weeks and months. This could lead to difficult decisions by central banks, who may feel the need to raise rates yet again to protect against runaway price rises.

The future of the global economy remains as uncertain as it was in March. But no one can deny it’s been a sudden, cliff-edge shift. With the market and policy dynamics now having flipped upside down, we are in a very different place – and the effects of this wrenching transformation will likely be felt for some time.

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Sudden Shift: Vanguard’s Active Fixed Income Insight