One thing is for certain. Central banks are now very much on the move. Month to date we have seen 24 banks change rates, 22 of those being hikes. For the most part, the size has exceeded by multiples the adjustments to policy we have become accustomed to in what from both a credit and rate perspective has been a benign period in history following the GFC and prior to the pandemic. It has been a somewhat abrupt reminder of what happens not just when the price of money goes up, but additionally stimulus begins to be withdrawn.
Talk of employment and growth have fallen by the wayside with targets squarely set on the rate at which everything is becoming less affordable. According to Citigroup on Wednesday, the probability of a global recession now stands at 50%, with Goldman Sachs, Morgan Stanley and others echoing many of the same concerns. The way out? Supply shocks waning and demand holding up. A soft landing would certainly be welcomed. The only things on sale here appear to be risk assets, but with fear globally of an inflation (and the blunt tool of higher rates) induced recession, the market at least seems to think it is all still too pricy.
Last week several central bank meetings had been scheduled. The ECB was not one of them. Concern was around the rapid widening of spreads between German government debt, the gold standard for European benchmarking and borrowing, and the peripheral nations further down the credit curve which are suffering from higher degrees of indebtedness, unemployment and lower growth.
Below the spread between Italian and German 10-year debt, widely used in capital markets to understand risk premia. The concern, mirrored to some extent across several jurisdictions, was not purely the outright levels but the pace of change and lack of liquidity exasperating this widening.
Source: Bloomberg LLP
As soon as the market heard of the emergency meeting to deal with “fragmentation”, the peak was hit. The devil, as always though, shall be in the detail. All of this whilst needing to deal with price rises well above target and harming demand. Forward guidance though, is still on track with hikes coming in both July and September, with money market traders predicting we close the year over 1.25% higher than where we are today. Good news for holders of cash at least, presuming it is passed on. We are certainly seeing considerably more opportunity to lock in at well above 1% now with several well-rated banks.
For the pound, Wednesday was not a good day. It was confirmed that inflation has remained elevated despite several hikes over the last several months from 0.10% to 1.25%. The 0.25% increase last week was a policy error if you ask me, and only puts the UK, and her currency, further into the danger zone. Finally, at least the likes of Bank Chief Economist Huw Pill and external voting member Catherine Mann highlighted the need to stop being a laggard. As a net importer of goods, a weakening currency adds fuel to the domestically grown inflation fire. One can understand some hesitance though with the latest GDP print for April showing a contraction of 0.3%, per the graph below.
Source: Office for National Statistics – GDP monthly estimate
Governor Baileys’ view that 80% of price rises come from overseas, and that nothing can be done about it is hard to accept. The market does not appear to love it either, and sees rates pushing towards the 3% mark before the year is out, which would be quite the pace over the four meetings to come. It is also not a small outright number, meaning if you hold cash, you really can earn a material return! If you are on the wrong end of floating rate debt, the picture is not quite so rosy.
The Federal Reserve did not disappoint last week with its 0.75% move, and all but committing to another move higher of this same magnitude for next month’s meeting. Employment has remained high and the dollar strong. This is most apparent when comparing with what has remained diametrically opposite policy in Japan, continuing to pump stimulus in and commit to lower for yet longer rates. If you are long dollar$ you can at least party like it’s 1999 in Tokyo right now.
Come the end of the year, interest rate futures at least, tell us 3.5% will be breached as the Fed continues, mercilessly, to hike rates in a valiant attempt to get prices back under control. At what cost to the economy? Only time will tell… One thing is certain, it will not be a dull second half of the year.