Εβδομαδιαία Επισκόπηση: Διεθνής Οικονομία & Αγορές, 20/09/22
Ahead of a slew of central bank meetings this week (FED, BOE, BOJ), government bond interest rates edged significantly higher
Key Takeaways
An unexpected increase in August’s US core CPI served as a wake-up call to investors to reassess whether the expected tightening will keep inflation in check. Core inflation rose by +0.6% mom (consensus expectations: +0.3% mom) with the three month annualized rate in the neighborhood just north of 7 percent.
Market-based expectations for policy rates were revised upwards following the CPI outcome, assigning roughly a 75% likelihood that USD short term reference rates will be 4.25%-4.5% or greater by end-2022.
Market expectations of future short term reference rates are the most prominent determinant of long term rates. As a result, 10-Year US Treasury nominal yields have increased by +35 basis points since early September to +3.5% (+197 bps ytd). The real interest rate component, based on TIPS, has risen by +43 basis points for the same period to +1.1%, a four year high (+224 bps ytd).
Equity valuations have tracked, inversely, the path of real interest rates. The S&P500 12-month forward P/E ratio declined to 16.5x from 17.4x in the past week, still trading in line with its 30-year average, as the numerator (price) tumbled by -4.8% wow. The multiple’s decline explains the price reaction year-to-date (-18%). On the other hand, consensus earnings estimates have been broadly unperturbed (2023 EPS: $240 from $248 in June, with 2023/2022 EPS expected growth of +8%), despite intensifying recession concerns.
The Federal Reserve is now widely anticipated to proceed on September 21st with another 75 bps hike in the federal funds rate to a range of 3.0% - 3.25%. Investors price-in a circa 80% probability for such an event (20% probability for +100 bps). The FOMC is also expected to revise higher its own estimates for the terminal policy rate, probably above 4.25%.
The Bank of England appears poised for a 50 bps hike to 2.25% for the Bank Rate on September 22nd. Investors’ pricing based on sterling overnight index swap rates suggests a terminal rate of 4.5% (versus 4.25% a week ago).
Attention also turns to the meeting of the Bank of Japan on September 22nd, as the large monetary policy divergence with other major central banks, has led to a sharp depreciation of the Yen, especially against the US Dollar, by -24% year-to-date, to ¥143. Still, latest officials’ commentary supports the view that the BoJ will stand pat, albeit risks are on the upside.
Having said that, recent reports that Japan’s Ministry of Finance is considering an intervention in foreign exchange markets to support the Yen, offered some respite (+0.8% compared with September 7th when the Yen hit its lowest since August 1998 against the US Dollar, at ¥144.50).
Investors also keep an eye on Italy’s general elections on September 25th. According to polls, the most likely outcome entails a right-wing coalition government led by the Brothers of Italy party. In such an event, the focus will mainly be on national recovery and resilience execution (NRRP) and fiscal policy plans. So far, the BTP/Bund spread has been on the low side of the 2018 elections’ range (240-330 bps).
Key Takeaways
An unexpected increase in August’s US core CPI served as a wake-up call to investors to reassess whether the expected tightening will keep inflation in check. Core inflation rose by +0.6% mom (consensus expectations: +0.3% mom) with the three month annualized rate in the neighborhood just north of 7 percent.
Market-based expectations for policy rates were revised upwards following the CPI outcome, assigning roughly a 75% likelihood that USD short term reference rates will be 4.25%-4.5% or greater by end-2022.
Market expectations of future short term reference rates are the most prominent determinant of long term rates. As a result, 10-Year US Treasury nominal yields have increased by +35 basis points since early September to +3.5% (+197 bps ytd). The real interest rate component, based on TIPS, has risen by +43 basis points for the same period to +1.1%, a four year high (+224 bps ytd).
Equity valuations have tracked, inversely, the path of real interest rates. The S&P500 12-month forward P/E ratio declined to 16.5x from 17.4x in the past week, still trading in line with its 30-year average, as the numerator (price) tumbled by -4.8% wow. The multiple’s decline explains the price reaction year-to-date (-18%). On the other hand, consensus earnings estimates have been broadly unperturbed (2023 EPS: $240 from $248 in June, with 2023/2022 EPS expected growth of +8%), despite intensifying recession concerns.
The Federal Reserve is now widely anticipated to proceed on September 21st with another 75 bps hike in the federal funds rate to a range of 3.0% - 3.25%. Investors price-in a circa 80% probability for such an event (20% probability for +100 bps). The FOMC is also expected to revise higher its own estimates for the terminal policy rate, probably above 4.25%.
The Bank of England appears poised for a 50 bps hike to 2.25% for the Bank Rate on September 22nd. Investors’ pricing based on sterling overnight index swap rates suggests a terminal rate of 4.5% (versus 4.25% a week ago).
Attention also turns to the meeting of the Bank of Japan on September 22nd, as the large monetary policy divergence with other major central banks, has led to a sharp depreciation of the Yen, especially against the US Dollar, by -24% year-to-date, to ¥143. Still, latest officials’ commentary supports the view that the BoJ will stand pat, albeit risks are on the upside.
Having said that, recent reports that Japan’s Ministry of Finance is considering an intervention in foreign exchange markets to support the Yen, offered some respite (+0.8% compared with September 7th when the Yen hit its lowest since August 1998 against the US Dollar, at ¥144.50).
Investors also keep an eye on Italy’s general elections on September 25th. According to polls, the most likely outcome entails a right-wing coalition government led by the Brothers of Italy party. In such an event, the focus will mainly be on national recovery and resilience execution (NRRP) and fiscal policy plans. So far, the BTP/Bund spread has been on the low side of the 2018 elections’ range (240-330 bps).