Weekly View - A hawkish Christmas
Last week saw four major central banks all hike rates by 50bps, as expected. While they were unanimous that the fight against inflation would take more time, nuances in their communication prompted varied market reaction. In the UK, markets concentrated on the recessionary impact of the rise in the bank rate to 3.5% and the prospect of further rises to come, while Swiss markets did not like the Swiss National Bank’s refusal to rule out using the currency to counter imported inflation as it raised its policy rate to 1.0%. In the US, Federal Reserve chairman Jerome Powell warned that the recent rise in markets was resulting in an easing of financial conditions that ran contrary to the Fed’s aim to dampen inflation and he expressed his anxiety about the tight labour market. Fed officials also raised their forecast for the terminal Fed funds rate to 5.1%. The real surprise was the European Central Bank’s (ECB) decidedly hawkish tone, with a “substantial upward revision” in staff projections for inflation giving it ample justification for further hefty rate hikes early next year. It also announced that quantitative tightening will start in March, initially at EUR15 bn per month.
There was a dichotomy in bond markets’ reaction to the latest rate hikes. US Treasuries rallied, but European bonds sold off, including Bunds. Germany's large issuance schedule next year has some questioning its status as a ‘safe haven’. We are overweight duration in US bonds and underweight European periphery bonds, with convergence between US Treasury and European bond yields one of our key investment themes for 2023. Central banks’ reaffirmation of their commitment to beating inflation came despite data indicating further weakening of growth momentum. In the US, retail sales weakened in November, while business activity in Europe continues to contract despite a better-than-expected purchasing managers’ index for this month. In China, figures for retail sales, fixed-asset investment and industrial production in November all came in below expectations while the unemployment rate in the largest 31 cities rose from 6% to 6.7%. Covid is spreading very fast in China’s large cities, disrupting daily life and economic activity after ‘re-opening’. Also in Asia, the latest Tankan survey shows inflation expectations rising in Japan, supporting our view that the Bank of Japan will be forced to adjust its yield curve control.
The NFIB Business Optimism survey showed a plunge in US companies planning to increase inventories to the lowest level in six years. This does not bode well for top-line revenues in 2023 and we believe earnings expectations need to come down further. We are underweight equities. Elsewhere, the Dutch government’s plans to close some 3,000 farms in a bid to comply with EU environmental requirements is an indication of how costly the green transition will be. Congratulations to Argentina on their exciting and well-deserved World Cup victory.