Week ended Dec 16, 2022
The major central banks of the US, the UK and the Eurozone did exactly what they had telegraphed this week during the lead-up by raising their overnight bank rates 50bps. Risk markets took note but – as is
often the case – it was what was conveyed in press conferences following the official releases that mattered the most. The graph to the right illustrates the recent path of interest rate increases for the three economic zones, courtesy of the FT.
In theory, these expected rate increases should have been “just another day in the office” as central banks continue to tighten policy in their quest to bring down inflation. However, the heads of the ECB and the Fed were direct and unquestionably hawkish in press conferences following the release of the official policy decisions. (I do not think the BoE held a press conference following the monetary policy release.) Perhaps what most rattled investors were reminders that the terminal rates might ultimately be higher and are likely to remain at peak levels longer than investors have been anticipating.
Since US equity investors seem to have been conditioned to listen carefully for the slightest glimmer of hope of a Fed pivot, Mr Powell was particularly careful at his press conference/Q&A not to say anything that might sound even slightly dovish. Mr Powell’s comments were consistent with the revised Economic Projections (here) provided by the Fed following the FOMC meeting.
The revised dot plot (vis-à-vis the September projections) suggests a higher terminal rate for longer. The dot plot suggests that the terminal Fed Funds rate will be 5%-5.25%, or 75bps more than the current 4.25%-4.50%, and that the rate will stay at this level until 2024. Market expectations are that the Fed will raise the Fed Funds rate a further 25bps at each of the first two FOMC meetings in 2023 before considering further moves.
Perhaps what rattled investors most is that the Fed revised down its economic assumptions for 2023 vis-à-vis the projections it presented following the September FOMC meeting, projecting lower GDP growth (0.5%), higher unemployment and – perhaps most concerning – higher inflation (PCE).
The following day, the ECB took a similar approach at its press conference, with Ms Lagarde taking a more hawkish stance than in the past. I have a difficult time believing that the two European central banks can stay as hawkish in the coming quarters as the Fed because their respective economies are more fragile (than the US) albeit for different reasons.
The other bit of economic data which emerged this week was inflation reads for the US, the UK and the Eurozone (final). The data across the board showed that inflation was trending in the right direction although still well above the target 2% CPI target for all three economies.
US: Nov CPI was 0.1% MoM (vs Oct) and 7.1% YoY, down from 7.7% YoY for October. Core inflation (ex-food, ex-energy) in Nov fell to 6.0% YoY. BLS CPI report for Nov released Dec 13th, here.
UK: Nov CPI was 0.4% MoM (vs Oct) and 10.7% YoY, down from 11.1% YoY for October. Core inflation (ex-food, ex-energy) in Nov fell to 6.3% YoY. ONS CPI report for Nov released Dec 14th, here.
Eurozone: Nov CPI was nil MoM (vs Oct) and 10.1% YoY, down from 10.6% YoY for October. Core inflation (ex-food, ex-energy) in Nov fell to 5.0% YoY. Eurostat CPI report for Nov released Dec 16th, here.
I mentioned the Fed’s revised economic projections, but the ECB also released revised projections and provided a hawkish tone during the post-monetary meeting press conference. Ms Lagarde, like Mr Powell, took a decidedly hawkish tone, noting that “inflation remains far too high and is projected to stay above our target for too long”. The ECB will continue to raise rates and will also start its QT programme in March – joining the Fed and BoE – by allowing around €15 billion of maturing securities to run off its balance sheet each month. As far as projections (and similar to the Fed’s revised projections), the ECB revised inflation up for 2023 and economic growth down, saying that the Eurozone is already in a recession that is likely to continue through the 1Q2023.
This week, I intend to update the article I wrote on central banks recently to reflect the monetary policy changes that occurred at this week’s policy meetings. I am also working on an equity valuation article, which I think is interesting as equities remain on a knife’s edge, or so it feels. Assuming I get both of these written, I intend to write a limited weekly next week (perhaps just tables) given the time of year but should be back with a year-end summary in early January.
MARKETS THIS WEEK
Having briefly touched 4,100 intraday on Tuesday after a fairly nice run over several days, you might have thought that US equity investors were set for the expected 50bps increase in the Federal Funds rate announced Wednesday afternoon. However, investors clearly were not prepared for Mr Powell’s hawkish comments following the FOMC release. Perhaps a better-than-expected CPI read the day before got investors thinking that the Fed would back off, but it wasn’t to be. Having stabilised Wednesday morning, the S&P 500 shed nearly 60 points in the last two hours of Wednesday’s session following the FOMC decision and Mr Powell’s press conference. The next two days were also ugly as the index managed to erase early-week gains ending with a loss of 2.1% WoW. It felt worse though, probably because sentiment shifted so quickly that it caught many investors off-guard.
Bond investors were clearly less rattled, as the Fed’s decision and revised projections increased their conviction that slower economic growth is coming. This reality, supported by lower CPI in November, helped pushed UST yields down (prices higher), a reversion to the post-pandemic negative correlation between stocks and bonds. The decline in yields during most of the post-pandemic period has normally caused stocks – especially long duration (negative cash flow) names – to rally. However, equity investors might be catching on finally to the drag on equities which will result from slower economic growth or even a recession. Ah, have we returned to the world of stocks and bonds being negatively correlated? One week is by no means long enough to make this call, but perhaps we are starting - shall we say - a reversion to normalcy. As dire as things felt in US equities, stocks were worse in Europe, with both the FTSE and the STOXX 600 getting battered after rates decisions. In fact, equities provided no joy anywhere this week – equity indices were universally bad. US dollar-denominated corporate credit spreads also drifted wider this week albeit only modestly. European high yield spreads went the other way - don’t ask me why given the depressing news on the outlook for the European economy. The US Dollar was more or less flat whilst gold and Bitcoin were weaker. Crude oil was better on the week, although it remains sharply lower over the last month.
Below is a summary of financial indices and assets for the week, with more detail provided in the section “The Tables”.
Trading volumes will likely diminish sharply as we approach the end of this week, with various holidays the week between Christmas and New Year’s making for sporadic trading. Below are some of the key data and economic releases and other events that matter for the weeks ahead.
The coming week will be light as far as data except in the US (housing data, consumer confidence, revised 3Q22 GDP, and the all-important PCE figure for November, the most-monitored inflation barometer for the Fed). The BoJ also has a monetary policy meeting which is expected to be (as usual) uneventful.
Market holidays in the coming two weeks are Monday, December 26 (Christmas observed) in the US, the UK and Eurozone; Monday, January 2 (New Year’s observed+other) in the US, UK, Japan and China; December 27 (Boxing day observed) in the UK.
Upcoming central bank meetings (expectations in brackets for BoJ):
Bank of Japan – Dec 19th-20th (no change expected) and Jan 17th-18th
Federal Reserve – Jan 31st/Feb 1st and March 21st-22nd
Bank of England – Feb 2nd and March 23rd
ECB – Feb 2nd and March 23rd
Corporate bonds (credit)
Safe haven and other assets
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