Central banks are now tightening monetary policy – some faster than others. We carry a range of reactions from economists and strategists.
Interest rates are rising everywhere. Yesterday, the US Federal Reserve announced its biggest increase in the benchmark Fed Funds rate since 1994, at an 0.75 percentage point (to 1.75 per cent). The Swiss National Bank, which has been running negative official rates for about seven years, has moved from -0.75 per cent to -0.25 per cent. The Bank of England today, as expected, raised its official rate by 0.25 per cent, or 25 basis points, to 1.25 per cent. The European Central Bank has clearly flagged that it is going to start tightening.
Recent months have seen inflation rise strongly to multi-decade highs, bringing back memories of the late 70s and early 80s (at least for those old enough to recall this episode). The reasons for the inflation pressure are various: a decade of central bank quantitative easing (a form of monetary creation); pandemic-induced supply chain disruptions, Green energy transition policies that have squeezed oil and gas production such as fracking, and the Russian invasion of Ukraine. Not all these events work in the same way, and are susceptible to rises in borrowing costs. There’s a risk of recession.
Whatever happens, a world of rising inflation and rates presents wealth management advisors with asset allocation and risk management decisions they may not have had to confront for many years. (Some younger advisors may not even have been in a job the last time there was a recession.) So what do they make of what central banks have done?
Here are reactions
UBS, Global Wealth Management, commenting on the
We see no reason to change our broad investment theme of favoring value over growth, but the events of the past week do increase the difficulty of Fed policy achieving a “softish landing.”
However, in our view, the bond market’s reaction to the data, bringing 10-year yields toward 3.5 per cent at the start of this week, was a signal to the Fed that it had lost too much of its inflation-fighting credibility. The Fed’s rapid response – a 75 bps hike – is a sign that it intends to win that credibility back at a higher risk of recession.
The Fed’s messaging is likely to continue to be hawkish until we see clearer evidence of a deceleration in inflation. The stubbornness of inflation and the shift in the Fed’s reaction function have pushed up expectations on the terminal rate, which at the time of writing is priced at just under 4%. Although the Fed may not need to hike all the way to 4% in practice, the risk that it does so has increased, and with it the risk of a recession.
Taking this into account, we forecast 10-year US Treasury yields to trade at 3.25 per cent by December and acknowledge they may trade even higher in the interim. Volatility in bond markets is likely to continue with each policy announcement and each new data on inflation and inflation expectations. We expect yields to decline more sustainably only in 2023 as inflation fears pass and as the market begins to consider the possibility of future rate cuts to support growth.
Homin Lee, Asia Macro Strategist at Lombard Odier,
commenting on the Fed
Three things about the Fed’s new communication stands out, in our view. First, the median of the new FOMC projections show a rate cut in 2024 despite penciling in an above-target core PCE (personal consumption expenditure) inflation of 2.3 per cent for the year. This shows that the median forecaster in the committee wishes to cap the real interest rate in the US at 1.2 per cent in 2023 and 2024.
Second, the FOMC expects both growth and labor markets to keep softening in the rest of 2022 and 2023, partly due to its frontloaded tightening. This suggests that the Fed will monitor possible deceleration in real indicators such as output and unemployment in the medium term despite its current inflation focus. Third, Chair Powell in his press conference has made the magnitude of the rate hike in July conditional on incoming data. This means that softer May PCE inflation (to be released on June 30) or June CPI inflation (to be released on July 13) could lead to a smaller 50 bps hike in the next FOMC meeting (scheduled on July 26 to 27). In light of surprisingly weak retail sales data for May, markets are now pricing a rate hike that is halfway between 50 bps and 75 bps for the July meeting.
In aggregate, these messages suggest that the Fed is holding onto its soft-landing ambitions with aggressive frontloading of rate hikes in 2022 and a slightly higher inflation tolerance in the long-run. This stance is not significantly different from what market now expects, as the Fed’s median forecast for fed fund rate is close to the fed fund futures market pricing for 2022 year-end prior to the meeting.
Capital Economics, commenting on the Swiss National
Given its history of making unscheduled policy announcements, we think it more likely than not that the [Swiss National] Bank will raise interest rates again, to over zero even into positive territory, before the next scheduled meeting, in September.
Given the shifting global policy landscape it was always a case of “when” rather than “if” the SNB would start to normalize its policy settings. As a result, as policy shocks go, today’s decision is not in the same league as the ‘Frankenshock’ in 2015. Nonetheless, whereas 2 of 26 respondents to a Reuters survey had predicted a 25bp hike today, a 50bp move blindsided all SNB-watchers.
Consumer price inflation in Switzerland is currently much lower than in the euro-zone (2.9 per cent versus 8.1 per cent), but today’s move shows that Swiss policymakers have clearly seen enough. The Bank explained that “tighter monetary policy is aimed at preventing inflation from spreading more broadly to goods and services in Switzerland.” It also raised its conditional inflation forecasts to 2.8 per cent in 2022 (previously 2.1 per cent) and 1.9 per cent and 1.6 per cent in 2023 and 2024 respectively (both previously 0.9 per cent), and noted that the forecasts “would be significantly higher” in the absence of today’s rate rise.
BlackRock, Rick Rieder, chief investment officer of
global fixed income and head of the BlackRock global allocation
In the coming months, we think it’s increasingly likely that we’re going to witness a growing “wedge” between the core PCE measure of inflation and the headline CPI [consumer price index] metric, which can’t be ignored. One of the key reasons for this divergence will be the likely role of volatile food and fuel prices, which may keep headline inflation sticky on the high side, even as core PCE moderates somewhat. It seems fairly clear to us that if inflation doesn’t broadly cool off in the next several months, it will be due to higher than anticipated food and energy price increases.
Hence, the action on Wednesday was very much needed and will ultimately be viewed as beneficial in its speed and for drawing policy closer to neutral, with a clear set of intentions to get there and at least a bit beyond. Whether this will require markedly tighter policy from that point is still unclear. In fact, this proverbial automobile may require being put into drive at that stage, versus in reverse, as the amazingly flexible and adaptive US economy will self-calibrate itself to a slower demand function over the coming weeks and months. But being in neutral will allow the vehicle of policy adjustment to adapt and pivot to what is required months from now. Predicting where that will be is not clear to virtually anyone but being in the front-seat with a firm hand on the gear shift is where the Fed is closer to being now and the economy, and markets, will ultimately benefit.
Ben Laidler, global markets strategist at social
investment network eToro, on the Bank of England
The Bank of England is walking an increasingly uncomfortable line between curbing inflation and tipping the economy into a recession, with the UK the global poster-child for stagflation. Today's fifth straight interest rate hike, by 0.25 per cent to 1.25 per cent, is being left behind by more determined central banks like the US Fed.
UK inflation is running at 9 per cent, the highest among developed economies, and it's set to rise even further in the coming months given the October fuel price cap and the fact that natural gas prices are surging again this week. Meanwhile unemployment is at a 25-year low and wage expectations are rising.
The more gradualist approach by the Bank of England may spare some pain for the UK economy for now, but is keeping long-term inflation expectations well above those in the US, and undermining sterling. A weaker pound may be welcomed by many exporters and the FTSE 100, but it also supports high-for-longer inflation and hurts more domestic-focused mid caps like the FTSE 250.