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Last week’s signals from the Federal Reserve and European Central Bank that their rate-hiking cycles are set to continue in July was not sufficient to end a three-month rally in US equities, nor to prompt a material rise in implied volatility. Economies have proved far more resilient to rate hikes than many had anticipated, with even a mini-banking crisis in March failing to light the recessionary touchpaper. This resilience has caused the VIX Index, the leading indicator of market uncertainty, to fall to its lowest level in three years and well below its average since 1990 of 19.6. Equity markets thrive in periods of low volatility; this time, market momentum has extended well beyond the US, with French and German equity indices hitting record highs this year and the Japanese index reaching a 33-year peak in June.

Markets seem increasingly confident that the Federal Reserve can restore inflation to target without requiring a deep downturn in economic activity. However, economic resilience to monetary tightening may mean that real rates stay higher for longer, with adverse consequences for asset prices. Thirty-year real rates are roughly 200 basis points higher than at the end of 2021 in the US and Germany, and a whopping 340 basis points higher in the UK, where the central bank’s challenge in restoring inflation to target appears the most demanding. The Bank of England meets this week, with markets pricing a one-in-four chance that policymakers will revert to a 50-basis-point hike after May’s 25-basis-point rise.

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