Yesterday marked the 25th anniversary of the start of my career in the City. Technically speaking, my career started in Canary Wharf, but you get the idea! Anyway, one thing that was quickly learned and has been demonstrated over many market cycles has been “don’t fight the Fed”. But once again financial markets don’t seem to be taking the US Federal Reserve (the Fed) at their word, even after another Fed meeting on Wednesday saw Chair Jay Powell reiterate that the fight against inflation still has a way to go and implying that markets are not pricing correctly both the ultimate level of interest rates, and for how long they remain at that level. It has been a busy week before hopefully it all goes quiet for Christmas – we have seen inflation data in the US and UK, along with central bank meetings in the US, UK and eurozone. The Federal Reserve, Bank of England and European Central Bank all hiked rates by 50bps, while inflation in both the US and UK was lower than expected.
The Federal Reserve ended a run of four consecutive 75 basis point interest rate hikes with a rate increase of 50 basis points, as expected, to a range of 4.25-4.5%. The ‘dot plot’ which records the expectations for future interest rates by Fed members, showed a median level for rates at 5.1% at the end of next year, which is well above market expectations. Fed Funds Futures see rates peaking at 4.87% in May before falling to 4.37% by next December. Fed Chair Jay Powell said that even with this latest hike, the Fed still had a way to go to make sure that the fight against inflation was well and truly won. Powell repeated his comments from the November meeting saying that the pace of increases was not nearly as important as the ultimate level of interest rates or the time spent at that level, pointing out the gap between the ‘dot plot’ level of rates and the level anticipated by financial markets. Powell said that the Fed needs to see “substantially more evidence” that inflation is abating and noted this process would “take some time; it’s good to see progress but let’s just understand we have a long way to go to get back to price stability”. Powell made a clear effort to push back on the market view that the Fed will not stay the course and will ease policy as the US economy and labour market weakens in 2023. The gap between the Fed and markets will need to be closed. Over the past decade, the dot plot has generally been too hawkish, but with the Fed determined to get to grips with inflation, this time the dot plot may be right, and if so, financial markets will need to adjust.
The Bank of England raised interest rates for the ninth meeting in a row, taking rates hiker by 50 basis points to 3.5%, the highest level since 2008. The Monetary Policy Committee saw a three-way split, with two votes for leaving rates unchanged, and one vote for a 75 basis point hike. Governor Andrew Bailey said that inflation may now have peaked, but risks to that projection were to the upside, with price growth remaining high in the coming months. The Bank still sees the UK economy as already in recession, albeit with fourth quarter growth less bad than the -0.5% seen in Q3. The lagged effect of the fiscal measures announced by Chancellor Jeremy Hunt allowed the bank to slightly upgrade their growth outlook for 2023, but this was offset by downgrades to the longer-term outlook as fiscal austerity bites after the next election. The European Central Bank, having twice raised rates by 75 basis points, increased rates by 50 basis points to 2% but ECB President Christine Lagarde made clear this was not a dovish ‘pivot’, saying “we should expect to raise interest rates at a 50-basis point pace for a period of time”. Lagarde said financial markets had not correctly priced the quantum of rate hikes yet to come from the ECB, saying “we have more ground to cover, we have longer to go and we are in for a long game”.
The UK inflation data was lower than expected, at 10.7% in November, down from a 41 year high of 11.1% in October. The easing in the pace of inflation was helped by base effects – in November last year energy prices climbed by 7.2% month on month whereas this year energy prices were flat. The decline in the pace of inflation was mainly due to lower petrol and used car prices; these were offset by food prices rising by 16.5% year on year, the fastest pace since 1977. Core CPI, which excludes food and energy, rose by 6.3%, down from 6.5% the previous month. While the inflation data in the UK may have peaked (energy price hikes next year may well have a further sting in the tail) the Bank of England still has work to do to get inflation anywhere near their 2% target. Base effects, as price hikes fall out of the year-on-year data will be helpful in this respect over the coming months but ultimately with the cost of living higher and wages lagging, UK consumers continue to face a tough environment. The latest employment data showed wages rising by 6.1% in the 3 months to the end of October while payrolls increased by 107,000, ahead of expectations. The unemployment rate was unchanged at 3.9%. The Office for National Statistics noted that October saw 417,000 working days lost to strikes, the highest level for a decade. The cumulative total days lost over the past 5 months is the highest since the 1990s. In the US, the inflation data was also lower than expected, and is now significantly lower than the 9.1% peak seen in June. US CPI for November was 7.1%, which was the lowest level seen this year and the fifth month in a row the pace of price rises has eased. Core CPI fell back to 6.0%. While the levels are still way above the Federal Reserve’s 2% target, but the direction of travel is clear. That said, while getting down towards 5% looks probable in the coming months, pushing inflation closer to target will likely need to see some economic pain; the lagged effect of the rate hikes we’ve seen this year, and likely recession as a result are likely to bring inflation lower as we see the US labour market also begin to cool.
China continues to see relaxations in Covid policies even though there has been no official declaration of an end to ‘Zero Covid’. China is now enduring an Omicron wave, expected to peak in late January though the official case numbers appear to be under-reporting given testing protocols have been relaxed and asymptomatic cases are no longer being recorded. The pressure on the Chinese healthcare system will increase in the coming weeks in terms of hospitalisations; meanwhile a mass vaccination program will attempt to protect the elderly from exposure. The Chinese government deactivated the national covid tracking app, which was deemed surplus to requirements given the ban on travel between provinces has been lifted though various local tracking apps remain in place. In the short term there will likely be some economic consequences given the likely numbers of people being infected but the demise, or at least the significant erosion, of zero-Covid should bring forward the China reopening theme and improve their economic prospects next year.
This will be my final update for 2022. Many thanks to all for your support and feedback over the course of the year. The next update will be in the form of the 2023 outlook, which you will receive on January 6th, and normal weekly service will resume on Friday 13th January. Until then, from all of us in the Multi-Manager team, we wish you, your families, and your clients a very Merry Christmas!
