Weekly View - Lift off!
Last Wednesday, the US Federal Reserve raised short-term rates (to a range of 0.25-0.50%) for the first time since late 2018 and promised to continue doing so throughout this year and next to bring consumer inflation down from an annual rate set to exceed 8%. Indeed, Fed officials are now pencilling in a fed funds rate of almost 2% by the end of this year. On top of this, Fed chairman Jerome Powell mentioned that the Fed is close to finalising plans to shrink its USD9 trn balance sheet. Despite these factors, plus the rise in Fed officials’ forecasts for inflation (they now see core inflation ending year at 4.1%) and the lowering of the Fed’s GDP growth forecast (from 4% to 2.8% in 2022), equity markets rallied strongly last week. True, market participants were able to latch unto apparent moves toward a peace deal between Russia and Ukraine and a drop in energy prices, but we should expect further bouts of volatility.
We received further evidence last week that the US is holding up relatively well, with February retail sales up 17.6% on the same month last year (whereas the ZEW survey of German economic sentiment fell to its lowest level ever). Yet markets’ concern that the Fed will derail the recovery by over-tightening policy can be seen in the flattening, and even inversion, of parts the US Treasury yield curve. Not all yield curve inversions lead to recessions, but all recessions have been led by inversions. At the very least, the US is rapidly moving into a late-cycle environment that will be particularly tricky to navigate, especially once the Fed actually starts to reduce its balance sheet.
Chinese markets focused on promises from Liu He, China’s top economic official, that unspecified market-friendly measures were coming. No doubt the authorities will roll out further economic stimulus to ensure the Chinese economy reaches the official 5.5% growth target this year, but China faces many challenges. Not only is it facing a flare-up in covid cases, but the property sector remains mired in difficulties, credit growth has been waning and household spending shows signs of fragility. We remain negative on Chinese equities for the moment. But while Beijing faces domestic challenges, reports that Saudi Arabia is edging closer to accepting the yuan as payment for oil shipments to China could provide another indication that the reserve status of the dollar could be challenged.