Global Economy & Markets, Weekly Roundup 14/02/23
US CPI slowed in January to 6.4% (year-over-year) from a peak of 9.1% in June, albeit core price pressures remain strong
Key Takeaways
Federal Reserve officials (Powell, Kashkari) made hawkish remarks in the past week, suggesting that the path of federal funds rate may need to be higher than markets’ expectations, especially if the strength of the labor market continues, while pushed back against expectations for interest rate cuts in H2.2023.
As a result, the respective pricing in futures markets moved up, with the terminal interest rate at a range of 5.0% - 5.25% (current FFR: 4.5% - 4.75%). Further out, market-implied paths are no longer consistent with expectations of a sizable reduction in policy rate by end-2023.
Strong labor market, with the unemployment at its lowest rate since 1969 (3.4%), endangers the sustained return of inflation to the Fed’s target of 2%. The US CPI report for January (February 14th) validated a strong impetus (+0.5% mom for the headline and +0.4% mom for the core index, seasonally adjusted) leading the annual growth to trivial changes from December (6.4% from 6.5% and 5.6% from 5.7%, respectively). Following the annual recalculation of seasonal adjustment factors by the BLS, core inflation appears a tad stronger.
On the other side of the Atlantic, ECB officials also stroke a hawkish tone in the past week. As a result, market pricing (according to overnight index swaps) moved up, pointing to roughly additional hikes of +115 bps for policy interest rates in the course of 2023 (current Main Refinancing Operations: 3.0%, Deposit Facility Rate: 2.5%).
The hawkish rhetoric from prominent central banks decision makers, was a key market mover in the past week. Government bond yields increased across the board, by +21 bps in the 2-year tenor in both the US and Germany, to 4.55% and 2.75%, respectively. Moreover, long-end yields edged higher by circa 15 bps to 3.74% and 2.36%, respectively. The inversion of the US Treasury yield curve -- short term interest rates above long-term bond interest rates – revisited its widest point since 1981, with the spread between 2s and 10s at -82 basis points, reigniting recession concerns.
Global equity markets lost some ground, with the MSCI ACWI Index down by -1.4% wow (+7% year-to-date and -11% year-over-year). The classic 60/40 portfolio, despite modest losses in the past week, has appreciated by +5% year-to-date, after experiencing one of the worst drawdowns on record in 2022. Overall, equity valuations are no longer convincingly cheap following the rally of +19% since October 2022 lows.
As risk aversion briefly increased, corporate bond spreads also widened. Nevertheless, spreads have tightened significantly since October 2022 by circa 100 bps to 423 bps, at odds with tight bank lending standards (see graph page 3). Indeed, according to the Fed’s Senior Loan Officer Opinion Survey, a substantial net percentage of respondents (+45%) reported for a 3rd consecutive quarter a tightening of lending standards for commercial and industrial loans.
Regarding commodities, Russia decided to cut its crude oil production by 500 thousand barrels per day (c. 5% of its total production and c. 0.5% of global supply) as of March, in response to price caps on imports of Russian crude and oil products. As a result, international oil prices rose meaningfully by +8% week over week ($86.4/barrel).
Key Takeaways
Federal Reserve officials (Powell, Kashkari) made hawkish remarks in the past week, suggesting that the path of federal funds rate may need to be higher than markets’ expectations, especially if the strength of the labor market continues, while pushed back against expectations for interest rate cuts in H2.2023.
As a result, the respective pricing in futures markets moved up, with the terminal interest rate at a range of 5.0% - 5.25% (current FFR: 4.5% - 4.75%). Further out, market-implied paths are no longer consistent with expectations of a sizable reduction in policy rate by end-2023.
Strong labor market, with the unemployment at its lowest rate since 1969 (3.4%), endangers the sustained return of inflation to the Fed’s target of 2%. The US CPI report for January (February 14th) validated a strong impetus (+0.5% mom for the headline and +0.4% mom for the core index, seasonally adjusted) leading the annual growth to trivial changes from December (6.4% from 6.5% and 5.6% from 5.7%, respectively). Following the annual recalculation of seasonal adjustment factors by the BLS, core inflation appears a tad stronger.
On the other side of the Atlantic, ECB officials also stroke a hawkish tone in the past week. As a result, market pricing (according to overnight index swaps) moved up, pointing to roughly additional hikes of +115 bps for policy interest rates in the course of 2023 (current Main Refinancing Operations: 3.0%, Deposit Facility Rate: 2.5%).
The hawkish rhetoric from prominent central banks decision makers, was a key market mover in the past week. Government bond yields increased across the board, by +21 bps in the 2-year tenor in both the US and Germany, to 4.55% and 2.75%, respectively. Moreover, long-end yields edged higher by circa 15 bps to 3.74% and 2.36%, respectively. The inversion of the US Treasury yield curve -- short term interest rates above long-term bond interest rates – revisited its widest point since 1981, with the spread between 2s and 10s at -82 basis points, reigniting recession concerns.
Global equity markets lost some ground, with the MSCI ACWI Index down by -1.4% wow (+7% year-to-date and -11% year-over-year). The classic 60/40 portfolio, despite modest losses in the past week, has appreciated by +5% year-to-date, after experiencing one of the worst drawdowns on record in 2022. Overall, equity valuations are no longer convincingly cheap following the rally of +19% since October 2022 lows.
As risk aversion briefly increased, corporate bond spreads also widened. Nevertheless, spreads have tightened significantly since October 2022 by circa 100 bps to 423 bps, at odds with tight bank lending standards (see graph page 3). Indeed, according to the Fed’s Senior Loan Officer Opinion Survey, a substantial net percentage of respondents (+45%) reported for a 3rd consecutive quarter a tightening of lending standards for commercial and industrial loans.
Regarding commodities, Russia decided to cut its crude oil production by 500 thousand barrels per day (c. 5% of its total production and c. 0.5% of global supply) as of March, in response to price caps on imports of Russian crude and oil products. As a result, international oil prices rose meaningfully by +8% week over week ($86.4/barrel).