The Cost of Credibility - Q4 2022

The Cost of Credibility

If there is a silver lining to a difficult third quarter, it is that the Federal Reserve appears to have finally caught up to inflation after being well behind the curve at the beginning of the year. To accomplish this, the Fed has had to raise rates at the fastest pace in 40 years. Yet after the upcoming November hike, it is likely that forecasts will show the Fed is close to the peak in Fed Funds. However, as monetary policy enters territory restrictive to economic growth, the disruptions to financial markets and the global impact of the Fed’s actions are becoming increasingly apparent.

Additional highlights

• Pension Solutions Monitor: We estimate that pension funding ratios increased over the third quarter of 2022, with the average funding ratio increasing from 94.0% to 95.6% during this period.
• Fixed Income: We are shying away from sizable macro bets with a wide distribution of outcomes, preferring to focus our attention on attractive idiosyncratic opportunities in domestic-oriented credits with positive catalyst to de-lever. With the fall of the old monetary regime occurring at breakneck speed, we caution that policy-induced accidents will likely become more commonplace in the coming quarters as markets hunt for a new equilibrium.
• Equities: Globally, equities declined 6.8%, with meaningful regional divergences largely driven by currency effects. The US was down nearly 5% compared to over 9% for developed ex-US markets and 11.6% for Emerging Markets.
• Liability Driven Investing: It is important to note that many of the factors that poised challenges for UK pensions as a result of the rapid changes in gilt yields are not features of the US market. UK liabilities tend to have a much higher duration than the US, mainly due to guaranteed Cost of Living Adjustments (“COLAs”) for inflation, as required by law.