Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Sometimes, all markets want is a little reassurance. After weeks of rising bond yields, US Federal Reserve chair Jay Powell could yesterday have eased worries by suggesting the Fed may look to tighten its ultra-loose monetary policy and so stem inflationary concerns. Instead, he did the opposite, giving no signs the Fed would look to tweak its policy for now. Why?

Powell will have chosen his words carefully. He knows they reverberate across global markets, sometimes with untold consequences. He’ll have learned this from one-time Fed chair, Ben Bernanke. In 2013, when musing about an exit strategy from the quantitative easing policy used since the Financial Crisis, Bernanke unintentionally triggered the ‘Taper Tantrum’, in which US Treasury bonds were sold off and stocks tumbled in panic.

Circumstances have changed since 2013 - investors now are worried about easing measures continuing rather than ending - but the outcomes look similar.

So why risk another tantrum? The truth is that none of what Powell said should have come as a surprise. The Fed is still way off its inflationary target of 2%, as it has been for over a decade, and it’s no secret that central banks are hoping inflation can help reduce the debt burden they’ve incumbered since the pandemic struck. Some degree of cyclical inflation looks inevitable, and perhaps necessary.

A little context helps as well. Powell’s comments yesterday did little to calm investors’ nerves, provoking a selloff in US ten-year Treasury bonds that spilled over into global stock markets. But these are nothing compared to recent tantrums.

In 2013, bond yields rose by 1.5% in a matter of weeks. Yesterday, they rose 0.06%. The S&P 500, meanwhile, closed down 1.3% - a significant but not earth-shattering fall. European and Asian markets have witnessed marginal falls and some gains. The Fed will be happy to see volatility like this if it keeps its inflation target within reach.

But that doesn’t mean investors aren’t worried about inflation. In an inflationary environment, your money has to work harder just to keep up. That risks devaluing future returns on your investments.

But inflation, when controlled, isn’t always a bad thing. A ‘goldilocks’ middle ground of 2-4% inflation has historically been best for equity valuations. Powell acknowledged this yesterday: “We expect that as the economy reopens and hopefully picks up, we will see inflation move up. That could create some upward pressure on prices.”

It’s clear then that the Fed doesn’t plan on changing things for the time being. It will keep policy loose, hoping to fuel growth and a manageable level of inflation.

What does that mean for investors?

One thing to be aware of is that such an environment could flip the hierarchy between last year’s winners and losers. The former - among them tech and pharma companies that profited from the pandemic - will generally do worse in a higher rate, inflationary environment. The latter - cyclical companies whose earnings floundered through lockdowns - can expect to do better in periods of growth.

No wonder that the tech-heavy US Nasdaq 100 index, home to some of last year’s tearaway successes like Tesla and Amazon, has turned negative for the year.

We’ll see diverging performances across asset classes as well. Oil prices have today risen to their highest levels in nearly 14 months - the result of both rising demand and limited supply due to output cuts imposed since the start of the pandemic. Bonds, meanwhile, could struggle to keep up.

Most of all, don’t expect a smooth ride. We got used to riding out market wobbles last year. Unfortunately, it looks like they’re not quite finished. This time round, the triggers are more likely to come from inflation expectations and yield curve control than lockdowns. Tom Stevenson, Investment Director here at Fidelity, explained these concepts in his most recent Market Week video, which you can find here or through the MoneyTalk podcast on your phone.

Just as we saw last year, a diversified portfolio of holdings is the best way to approach these unprecedented market conditions. That way you’re best covered for whatever happens next. If you’re looking for a well-diversified fund idea for this year’s ISA, a good starting point could be the Fidelity Select 50 Balanced Fund which invests across a range of different asset classes and sectors around the world.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates.  There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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