On March 16, the Federal Reserve (Fed) will celebrate the first anniversary of the current cycle of interest rate hikes. Just a few days later, Jerome Powell will announce a new upward move of at least 25 basis points to the 4.75-5% range, although more and more voices are warning of the possibility of a 50 basis point increase. .
The big strategists at Goldman and Bank of America (BofA) forecast making just two weeks three rate hikes in March, May and June of a quarter point, up to 5.25-5.5%, but now they are revising their models again. Now BofA is aiming even higher, up to 6%, 125 basis points above the current level. What has changed in such a short period of time to make the target rate change so quickly?
Firstly, the PCE price index, which measures personal consumption spending in the US, rose above expectations in January, up to 5.4% year-on-year, four tenths more than estimated and projects second-round pressures that the Fed want to avoid. It is the favorite indicator of the central bank because it combines indicators of employment and price developments.
The labor front is the one that worries Powell and the Fed governors the most, along with the price indices of the service sector. The imbalance between job supply and demand has plunged unemployment while maintaining a high number of vacancies in multiple sectors and regions of the US. In the opinion of the central bank, this behavior is not compatible with a destruction of demand or an economic recession either.
“The inflation readings are still not where we need them to be. [El informe PCE] It is simply consistent with the fact that the Fed needs to do a little more in our policy rate to make sure that inflation is coming down,” said Loretta Mester (Cleveland Fed) in statements to the Bloomberg agency. the January inflation report in the US came out stronger than expected (+6.4%) and the employment data (517,000) destroyed any forecast.
Back to Bank of America’s view, their view this week sees the Fed in a more aggressive mood than it was in mid-February. “Aggregate demand must weaken significantly for inflation to return to the Fed’s target. Further normalization of the supply chain and a slowdown in the labor market help, but only up to a certain point,” he says in a BofA report to which he had Reuters access.
Bond traders no longer view a possible Federal Reserve rate cut this year as a greater than 50% chance, according to the Bloomberg consensus. This represents a radical shift in investor expectations because until mid-January it was a majority thesis that the Fed would end up cutting interest rates in 2023 because the recession in the US economy was just around the corner. Powell already warned that this is what was happening in December: “I don’t think it can be classified as a recession because we have positive growth. It is modest, yes, but it is half a percentage point. That is positive.”
“Markets’ interest rate expectations have been determined by strong US economic data. The disinflationary narrative continues but rates may peak around 5.5% and stabilize at that level for an extended period, which would reduce the inflation around 3% by the end of 2023”, explains Stéphane Monier, chief investment officer (CIO) of the Swiss bank Lombard Odier.
“We continue to expect the US economy to experience recessionary bouts this year. Labor market dynamics and corporate earnings will be key trends to watch. In this environment, we are keen on a stock-neutral exposure, and would take advantage of market weakness to gradually increase exposure to risk”, adds Monier.
Also at the Dutch bank ING they are revising their rate forecasts upwards and the time they will last high due to the viscosity of prices at different levels. “We are in a new world where there are more inflation-prone circumstances that do not justify super low rates like we have had in the previous decade and a half. Those super low rates were brought about by the Great Financial Crisis and the reaction to the pandemic.” , point out Padhraic Garvey and Benjamin Schroeder.
Both ING experts forecast a horizon that is different from what has been experienced since 2008: “The mean reversion of the US 10-year Treasury bond yield of around 2% during these years does not make much sense in the future. We believe that the 3% is a more suitable starting point, which can be broken down as 2-2.5% inflation and a 0.5-1% real rate.” The 10-year debt yield is flirting in recent sessions with 4%, a key level for the evolution of the markets.
