Global Economy & Markets, Weekly Roundup 08/11/22
Central banks “stay the course” against inflation, with Fed raising the policy interest rate by 75 basis points to 4%
Key Takeaways
The Federal Reserve raised the Fed Funds Rate (FFR) by 75 bps at the November meeting to 3.75%-4.0%, as widely expected. Mr. Powell noted, that regarding the pace of future increases the Committee will consider i) the cumulative tightening of monetary policy (375 bps in 2022); and ii) the lags with which monetary policy affects economic activity and inflation.
The Fed pointed to a slower pace of rate hikes, starting as soon as the next meeting (December 14th), albeit at a terminal interest rate higher-than-previously expected. The median FOMC member rate forecast (“dot”) in September revealed the FFR at 4.625% in 2023. Investors’ expectations point to a terminal rate of 5%-5.25% in May 2023.
The Fed will remain data dependent. The labor market is tight, with the unemployment rate at 3.7%, and inflation pressures are strong (core CPI: 6.6% yoy in September), suggesting that any discussion about Fed “pause” or “pivot” is premature.
The Bank of England also raised by 75 bps the Bank Rate (the largest single hike since 1989) to 3.0%, citing its expectation that the rate will eventually not need to get as high as investors were anticipating prior to the meeting. Such levels would induce a larger hit to economic activity that the necessary one to get inflation back under control.
The BoE anticipates a sustained fall in UK GDP from H2:2022 up to H1:2024, mainly in view of squeezed real incomes due to high inflation. If confirmed, such a contraction would be the longest since 1955, albeit a relatively ”shallow” one. A cumulative fall of -2.9% in GDP is foreseen versus -6.3% during the Global Financial Crisis. These forecasts were conditioned on a market-implied path for the Bank Rate, which pointed to a peak of 5.25% in Q3:2023. The anticipated market-implied peak had eased to 4.75%. In that scenario, the BoE expects CPI inflation to end up well below the 2% target in 2025 (0%).
The S&P500 index lost -3.3% in the past week, as investors’ expectations for a dovish pivot in Fed’s monetary policy were dashed. US Treasury yields edged significantly higher (10-year: +14 bps wow to 4.16% & 2-year: +21 bps wow to 4.73%), with the upward trend continuing on Monday (+5 bps and +7 bps, respectively).
Attention now turns to US mid-term elections, with all 435 seats in the House of Representatives and 35 out of 100 in the Senate being contested. Currently, the Democrats control both chambers of Congress, as they have a narrow majority in the House of Representatives (222-213), while the Senate is divided (50-50), with Vice President Kamala Harris acting as the tie-breaking vote.
Prediction market-based pricing implies that Republicans will probably win the control of the House (88%), favored to win 227 seats (9 seats are rated as toss-up). Regarding the Senate, polls are projecting that the Republicans are favored to win 20 out of the 35 seats at stake, reaching 49 seats and the Democrats 12 seats, reaching 48 seats, while 3 seats (Georgia, Nevada, and Pennsylvania) are rated as toss-up. Prediction market-based pricing implies that the Republicans will also win the control of the Senate (65%-35%) minimizing the ability of substantial legislative initiatives.
Key Takeaways
The Federal Reserve raised the Fed Funds Rate (FFR) by 75 bps at the November meeting to 3.75%-4.0%, as widely expected. Mr. Powell noted, that regarding the pace of future increases the Committee will consider i) the cumulative tightening of monetary policy (375 bps in 2022); and ii) the lags with which monetary policy affects economic activity and inflation.
The Fed pointed to a slower pace of rate hikes, starting as soon as the next meeting (December 14th), albeit at a terminal interest rate higher-than-previously expected. The median FOMC member rate forecast (“dot”) in September revealed the FFR at 4.625% in 2023. Investors’ expectations point to a terminal rate of 5%-5.25% in May 2023.
The Fed will remain data dependent. The labor market is tight, with the unemployment rate at 3.7%, and inflation pressures are strong (core CPI: 6.6% yoy in September), suggesting that any discussion about Fed “pause” or “pivot” is premature.
The Bank of England also raised by 75 bps the Bank Rate (the largest single hike since 1989) to 3.0%, citing its expectation that the rate will eventually not need to get as high as investors were anticipating prior to the meeting. Such levels would induce a larger hit to economic activity that the necessary one to get inflation back under control.
The BoE anticipates a sustained fall in UK GDP from H2:2022 up to H1:2024, mainly in view of squeezed real incomes due to high inflation. If confirmed, such a contraction would be the longest since 1955, albeit a relatively ”shallow” one. A cumulative fall of -2.9% in GDP is foreseen versus -6.3% during the Global Financial Crisis. These forecasts were conditioned on a market-implied path for the Bank Rate, which pointed to a peak of 5.25% in Q3:2023. The anticipated market-implied peak had eased to 4.75%. In that scenario, the BoE expects CPI inflation to end up well below the 2% target in 2025 (0%).
The S&P500 index lost -3.3% in the past week, as investors’ expectations for a dovish pivot in Fed’s monetary policy were dashed. US Treasury yields edged significantly higher (10-year: +14 bps wow to 4.16% & 2-year: +21 bps wow to 4.73%), with the upward trend continuing on Monday (+5 bps and +7 bps, respectively).
Attention now turns to US mid-term elections, with all 435 seats in the House of Representatives and 35 out of 100 in the Senate being contested. Currently, the Democrats control both chambers of Congress, as they have a narrow majority in the House of Representatives (222-213), while the Senate is divided (50-50), with Vice President Kamala Harris acting as the tie-breaking vote.
Prediction market-based pricing implies that Republicans will probably win the control of the House (88%), favored to win 227 seats (9 seats are rated as toss-up). Regarding the Senate, polls are projecting that the Republicans are favored to win 20 out of the 35 seats at stake, reaching 49 seats and the Democrats 12 seats, reaching 48 seats, while 3 seats (Georgia, Nevada, and Pennsylvania) are rated as toss-up. Prediction market-based pricing implies that the Republicans will also win the control of the Senate (65%-35%) minimizing the ability of substantial legislative initiatives.