Analysis – Investors warn of policy misstep after cheering slower interest rate hikes
Rising inflation forced advanced economies to raise borrowing costs by a total of 25.15 percentage points over the period, the most aggressive rate in decades.
It is therefore not surprising that the central banks of the United States, the Eurozone and the United Kingdom will follow their smaller peers and slow the pace. US stocks up 13% from October lows; The 10-year Treasury yield fell 0.38 percentage point, or 38 basis points, in November, the most since March 2020.
However, markets still expect the Federal Reserve to raise interest rates by 100 basis points (bps) to 5% by the second quarter of next year. The European Central Bank, which has raised rates by 200 bp since July, is expected to nearly double its deposit rate to just below 3% by mid-2023.
With a potential spike in inflation and a looming recession, the risk of overtightening and accelerating a slowdown is on investors’ watchlist for next year.
“We’re past the point of a major (Fed) policy mistake, we think they’ve made it,” said Robert Waldner, head of macro research at Invesco, a $1.3 trillion asset manager.
“They were very aggressive. They raised a lot of rates in a very short period of time.”
The Fed’s latest research shows that the bank has exceeded the level required by general policy guidelines and should aim for 3.52%, up from its current target of 3.75%-4%.
Waldner said he would recommend a slower pace of tightening than markets expected. He believes rates are already tight, inflation has peaked and growth is slowing.
Oil prices, which have fallen 45% since February, have erased gains from 2022. Natural gas prices in Europe are still high, but are down about 60% from their peak in September.
Supply chain disruptions are reduced and producer prices are reduced or lower. ABN AMRO’s global bottleneck index returned to neutral in November for the first time since late 2020.
The latest inflation figures for the US and the Eurozone came in lower than expected.
Yes, economic growth indicators have been generally better than expected.
However, the UK economy shrank in the September-September quarter, putting it on the brink of a potentially long recession, US manufacturing contracted and business activity data pointed to a mild slowdown in the eurozone. According to a Reuters poll, the probability of a recession in the United States next year rose from 25% to 60% in June.
Chart: Global economic activity flashing red, https://www.reuters.com/graphics/GLOBAL-ECONOMY/byprllommpe/chart.png TIME GOES BY
Thomas Kosterg, chief U.S. economist at Pictet Wealth Management, worries about the gap between the outlook for an economic slowdown and the strength of labor markets, which the Fed wants to weaken.
In the US, mortgage rates have doubled this year, and applications have dropped by about 40%. According to alternative asset manager Apollo, home sales are falling faster than previous tightening periods.
The Fed survey, which takes into account mortgage premiums and corporate borrowing costs, found that financial conditions in September already reflected the equivalent of a 5.25% prime rate.
“The Fed is still based on historical data. I’m afraid the Fed is not taking into account the setbacks in monetary policy,” Kosterg said.
The OECD study also found that all advanced economies that raised rates at the same time had a bigger hit to growth and less of a reduction in inflation.
Former Fed economist Claudia Sahm said: “The Fed is seriously underestimating what will happen to the US economy if the global economy goes into recession.
HOW MUCH ?
Rising energy prices and supply constraints in the euro zone have largely fueled inflation, and some believe the ECB is going too far because its hikes cannot contain those pressures.
Militant politicians stress the importance of preventing a spiral in wage prices, but admit there is no sign of such a spiral emerging this year, with wages hovering around 4% against 10% inflation.
Chart: Will the ECB Slow Down? https://www.reuters.com/graphics/EUROZONE-MARKETS/ECB/mopaknxbjpa/chart.png The ECB also said the looming recession would probably not be enough to control inflation.
Peter Praet, the ECB’s former chief economist, told Reuters that such reasoning opens the door to a sharper cut without clarifying the depth of the recession the ECB believes is needed to bring inflation under control.
“What they have done so far is fundamentally correct, but the risk of error has not gone away.
Short-dated US and German bonds are yielding significantly more than long-dated bonds, leading markets to suspect that monetary policy will add to the economic pain. The yield on the two-year U.S. bond versus the 10-year bond recently reached its highest level since the early 1980s.
Erik Nielsen, chief economic adviser at UniCredit, said the ECB should take a break.
“My real concern is in 2023-24, when this year’s tightening of monetary policy will have the biggest impact on demand and will make households and businesses more vulnerable to rising energy prices…all because most of the fiscal support measures will need to be scaled back.” – he noted in a note.Chart: Deeply Inverted US Yield Curve, https://fingfx.thomsonreuters.com/gfx/mkt/mopakknxwpa/YCDEC.PNG