- At the beginning of March, strong economic and survey data suggested that the central bank hiking cycle led by the Fed was far from complete. This suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.
- In recent remarks to Congress, Fed Chairman Powell observed that “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”. His remarks carry two implications: 1) that the peak, or terminal, level of the federal funds rate is likely to be higher than previously indicated by Fed officials, and 2) that the switch last month to a smaller quarter-percentage point increase could be short-lived if inflation data continues to run hot. Clearly as monetary policy tightens further, the risk of a ‘hard landing’ beginning in the second half of the year increases.
- On the other hand, we are starting to see signs of distress in the market following the collapse of SVB and the rescue of Credit Suisse via an enforced merger with UBS. This has similarities with the LDI saga in the UK last year, which showed what can happen when interest rates move higher at a sharp pace. This echoes Buffet’s famous quip about finding out who has been swimming naked when the tide goes out. It also highlights that despite the ongoing strength of the labour market that policy tightening is impacting financial conditions more than was realised.
- This means that monetary policy (to control inflation) may conflict with financial stability objectives. As policy continues to tighten, we can expect further evidence of pain to emerge across the economy. This has led some commentators to wonder whether central banks will be able to follow through on their declared intention to bring inflation down to the 2% target. The BoE won’t want to risk crashing the UK housing market and the ECB won’t want to risk triggering another sovereign debt crisis in the periphery. The extent to which risks to financial stability conflict with monetary policy objectives will be worth keeping a close eye on in the coming months.
- According to Capital Economics, the US economy’s apparent strong start to the year in January looks increasingly like it was a ‘last hurrah’, possibly overstated by the unseasonably mild winter. The 236,000 increase in non-farm payrolls in March was the weakest monthly gain since December 2020. Alongside a slowdown in Job Openings and a change in direction in the trend of initial jobs claims, this suggests conditions in the US labour market may finally be close to peaking.
Please contact us for access to the full report which includes investment conclusions (E-mail: firstname.lastname@example.org, Phone: +44 (0) 1481 743 600)