Fynsa
After the downward surprises in inflation in October and November in the US. the market has been incorporating not only a slowdown in the pace of rate adjustment by the FED, but also a lower terminal rate and a direct "pivot" to incorporate cuts starting in the second half of 2023.
This contrasts with the intentions of the Fed itself and other central banks, of higher terminal rates and remaining at elevated levels for at least all of 2023.
Evidence of this can be found in this week's FOMC meeting, which raised the target range for the fed funds rate by 50 bps to 4.25%-4.5%, as widely expected, but with views expressed in the SEP (Summary of Economic Projections) of the federal funds rate by 50 bps to 4.25%-4.5%, as widely expected, but with the views expressed in the SEP (Summary of Economic Projections) decidedly hawkish, as the Fed intends to raise rates further to slow growth and raise the unemployment rate, to address the prospects of higher inflation for longer. (see table). The midpoint of the fed funds rate rose in 2023, from 4.6% to 5.1%, with only 2 FOMC members targeting a rate below 5.0% for 2023 (see chart). Median rates for 2024 and 2025 also rose 20 bps. The Committee still sees a first cut in 2024 as the most likely outcome.
At the same time, there was a significant reduction in GDP in 2023 and 2024, reflecting the impact of higher interest rates, while the Committee also raised expectations for core PCE inflation and the unemployment rate in 2023 and 2024, meaning that participants still see upside risks to inflation and downside risks to growth.The Committee also raised expectations for core PCE inflation and the unemployment rate in 2023 and 2024, meaning that participants still see upside risks to inflation and downside risks to growth, an unfriendly combination for risk assets.
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But it was not only the Fed that was more aggressive... While the ECB (European Central Bank) also moderated the pace of tightening with a rate hike of "only" 50 bps to 2.0%, it sees "significant increases in the future" to control inflation, sees "significant increases in the future" to control inflation, while announcing a plan to reduce the balance sheet by EUR15 bn per month from March 2023. Meanwhile, the Bank of England also hiked rates by 50 bps to 3.5% and said it would continue to respond "forcefully" if necessary.
Both central banks find themselves in an increasingly difficult situation as the emerging recession and financial stability concerns are balanced by ongoing wage pressures that risk embedding inflation.
So then, with the major central banks "insensitive" to the markedly downward trajectory in activity... How long does the logic that bad economic news is good news for the market hold? In our view, bad news is simply bad news, as corporate visibility for the coming year is increasingly compromised, while the likelihood of policy error and recession increases.
