January 06 2023
Some might have expected the first week back in 2023 to be a quiet affair. This has proved not to be the case, however. In the US we had the release of the December FOMC meeting. Whilst it could be argued that the press conference in December clarified the position of the central bank, the market is always keen to understand what was discussed at the meeting. The minutes confirmed that further interest rate hikes are considered appropriate and that a restrictive monetary policy stance is required to ensure that inflation remains on a sustained downward path towards 2%. Some committee members were also keen to note that past experience has shown that caution should be given to prematurely loosening monetary policy, with none believing it would be appropriate to begin cutting interest rates in 2023.
There is the possibility that they are concerned about the playbook of the 1970’s playing out and would like to avoid this. Research from MUFG Securities shows that the high inflation levels seen in the 1970’s was by no mean straight line. During this period inflation witnessed two peaks and troughs. Overlaying the path of US inflation onto the late 1960’s to mid-1970’s, they look eerily the same.
If current forecasts prove correct, inflation will indeed fall back to the 2% target level. It is then a second wave of higher inflation which the FOMC is clearly keen to avoid, as was seen in between 1976 and 1980. There are of course many dangers in simply extrapolating past trends onto the current market environment, but as the saying goes, history doesn’t often repeat but it does rhyme. For now, therefore, it would appear that the market and the central bank will remain at odds regarding the possibility of interest rate cuts in 2023. The Federal Reserve and indeed Goldman Sachs believe that the terminal rate in this cycle will be between 5%-5.25%. This is where they predict that they will end the year also. The market however currently believes that there could be up to 0.5% of cuts by this December.
A consequence of higher inflation and interest rates has, of course, been higher bond yields. It is not that long ago that investors were deeply concerned over the mountain of outstanding bonds which were negative yielding. Indeed, in December 2020 this was estimated by Bloomberg to have hit a staggering $18.3 trillion globally. The unwinding of this position, however, has been quick to say the least, with the same source believing that there was no negative yielding debt outstanding on the 4th January. This reversal potentially offers investors a stronger investment opportunity moving forward.
Finally, we ended the week with US non-farm payroll figures. These were a little stronger than forecast, although the number of jobs added, unsurprisingly, continues to fall compared to previous months. Whilst the unemployment rate fell, this is expected to pick up during the course of the year, having already seen job cut announcements from tech firms. What was perhaps a little surprising was the release of average hourly earnings, which came in at a lower than expected 4.6%, despite the tight labour market. This may add further fuel to those expecting the Federal Reserve to cut interest rates this year.
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