Ear to the Ground

November 24 2022

A little quieter on the economic front this week. The release of the FOMC minutes from the previous meeting contained no real surprises and reflected very much what was said by Chair Powell in the post-meeting press conference and statements made by other Fed governors since. The Minutes confirmed the Committee believe that it may now be appropriate to slow the pace of future increases in terms of the magnitude of future rises. They also recognised that signs that inflation was showing no signs of abating could mean that the ultimate level of the federal funds rate to achieve their inflation objectives may be higher than previously expected.

There remains a lack of consensus forecast for where this rate will peak across major investment banks, with a range low of 4.75% to a high of 5.75%. A simple mean across those surveyed gives a rate of 5.18%, with a median of 5.25%. There also remains little consensus as to where this rate will be at the end of 2023. Some banks forecast that we will still be at peak rate, whilst others forecast that we will have seen a varying degree of rate cutting by then. The most aggressive regarding the latter is UBS who, after seeing rates peak at 5%, forecast cuts taking us back down to 3.25%, perhaps reflecting a more optimistic view of the US economy. The market meanwhile is pricing in rate cuts which would take the federal funds rate down to 4.5% by January 2024.

Perhaps supporting the view that the Fed will be cutting rates during next year was the release this week of the S&P Global Flash PMI survey. Here we saw the Composite index continue its fall below 50, with a reading below 50 indicating contraction. The Services element posted a reading of 46.1, whilst Manufacturing moved into contraction territory with a reading of 47.6, well below the consensus forecast of 50.

When it comes to interest hikes, there is no doubt that the Federal Reserve will be looking to manufacture a soft landing. They have a history of not achieving this and some market commentators point out that the peak in the rate has historically tied in with some crisis or another. For example, the rise in 2020 tied in with the repo crisis, 2007 the subprime crisis, 2000 the tech bubble, 1987 the stock market crash and 1983 the Latin American debt crisis, to name but a few. Here is hoping that this time round the peak in US rates can pass quietly.

Higher short-term rates have given rise to higher shorter-term bond yields. Longer-term bond yields, meanwhile, whilst higher than previously, have not risen to the same extent. This has given rise to inverted yield curves. We have commented on this event in the US market in previous editions, particularly concerning the 10-year/2-year yield curve inversion. It is also the case for the same German bund yield curve too. This curve is now at its most inverted level in the last 30 years. As we have said before, an inverted yield curve does not cause a recession, but it has previously been a good indicator that one is imminent.