A very busy week inside and out of financial markets
I’ll focus on the latter, but we’ve seen interesting times for Donald Trump, Boris Johnson, Nicola Sturgeon, Manchester City and Ferrari at Le Mans over the past 7 days! The week in financial markets has been dominated by the central bank meetings, with the European Central Bank hiking rates again while the Federal Reserve, for the first time since early 2022, chose not to increase interest rates.
As expected, the US Federal Reserve chose to pause hiking interest rates at their meeting this week, ending a run of 10 consecutive rate increases stretching back to March of last year, which has seen rates climb to a range of 5-5.25%. The statement following the meeting said that “holding the target range steady at this meeting allows the committee to assess additional information and its implications for monetary policy”. Fed Chair Jay Powell noted that nearly all Fed officials expect it will be appropriate to raise interest rates “somewhat further” in 2023. Powell said that the Bank is still waiting for evidence that inflation was “slowing decisively”, adding “we’re just not seeing a lot of progress… we’re going to have to keep at it”. The messaging from the Fed made this a hawkish meeting overall, despite the absence of the further rate hike.
The summary of expectations shows the majority of Fed members see rates above 5.5% at the end of this year, with Powell saying he sees “no chance” that rates will fall in 2023, adding “not a since person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate”. Powell noted that core inflation remains high and has not yet responded significantly to policy tightening. Markets are expecting the resumption of rate hikes next month – the path beyond July is likely to be driven by how much inflation, and particularly core inflation shows signs of moving lower because of the Fed’s actions over the past 15 months.
The People’s Bank of China has been moving in the opposite direction in terms of policy following meetings this week which have seen the Bank pivot to a more dovish stance by making 10 basis point cuts to short-term borrowing rates. While the size of the cuts is minimal, it does point to a shift in stance by the Chinese central bank, whose concerns over inflation in the aftermath of the post-Covid reopening have not been realised. Indeed, with the data pointing to a somewhat underwhelming, and unbalanced, recovery in the economy, there has been a growing expectation of monetary easing, and a broader move, which we are yet to see, from the Chinese authorities to stimulate a recovery that appears to be lacking momentum if recent data is a guide.
The European Central Bank also met this week, raising rates by 25 basis points to 3.5%, the highest level in 22 years. The rate hike came with a signal that rates will increase further next month, as the ECB raised its inflation forecast and cut its growth forecast for the next 3 years. ECB President Christine Lagarde said the Bank “still has ground to cover” and would probably tighten policy at the next meeting in late July in the absence of a “material change” in the economic data. The Bank warned that it expects inflation to remain “too high for too long”, with CPI not returning to the 2% target until 2025. Lagarde said the ECB was yet to see a ‘wage price spiral’ but wanted to avoid a situation where workers demanding higher wages caused companies to push up prices to preserve profits. Overnight we’ve also seen the Bank of Japan meeting conclude but with no surprises with the Bank maintaining rates at -0.1% despite inflation of over 4%. The Bank’s messaging was on the dovish side, noting risks to the global outlook and indicating it will “not hesitate to ease further if necessary”.
The economic data this week has seen the UK employment data seeing unemployment ease to 3.8% with wages rising at 7.2% year on year. The news caused a significant shift higher in expectations for UK interest rates thanks to signs of the wage-price spiral that Andrew Bailey has referred to previously seemingly coming to fruition. Elsewhere inflationary pressures showed signs of easing, at the headline level as well, with CPI at 4.0% year on year in May – the slowest pace of inflation for over 2 years. Core CPI however, which excludes food and energy prices, was stubbornly high at 5.3%, ahead of expectations. The US PPI data, which is a leading indicator for inflationary pressures, continued to ease, with PPI falling month on month in May, by 0.3%, and climbing only 1.1% over May last year.
Chinese data disappointed, adding to expectations that stimulus will be needed to boost the economy. Industrial Production, retail sales and fixed asset investment all saw positive growth, but were below expectations. The post Covid recovery continues to appear skewed towards consumption, with retail sales up 12.7% compared to May 2022 while industrial production was up 3.5%. The property sector also remains weak, with new construction starts in the first 5 months of 2023 down 23% compared with 2022 despite the economic reopening. The reopening has done nothing to improve the dire situation with youth unemployment, which reached 20.8%, the highest level on record. Overall unemployment was unchanged at 5.2%. The Chinese National Bureau of Statistics said second quarter growth would be “significantly faster” than the 4.5% seen in the first quarter but warned that the “international environment was still complicated and severe, and the foundation for the economic recovery is not yet solid”. The relatively conservative 5% growth target for 2023 will likely need some targeted support for some sectors of the economy if it is to be achieved.
The Bank of England doesn’t meet until next week, but the wages data mentioned above was enough to convince markets that rates still have a long way to go before the Bank of England has inflation under control. Markets are pricing at least 5 more 25 basis point hikes before the end of the year, which would take interest rates to 5.75%. The shift higher in expectations has seen bond yields move higher, though unlike in September when the Liz Truss/Kwasi Kwarteng mini budget spooked markets, we have seen sterling strengthening. This suggests markets are expecting relatively higher rates in the UK than elsewhere, which given the ‘stickiness’ of inflation over recent months seems plausible. We expect to see more ugly headlines around mortgages ahead…
Have a good weekend,
Regards,
Anthony.
