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Saturday 15th July 2023
Friday Forward Guidance ... What Next For Rates ...
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| | Hi Friend,
Last month, the
Fed held rates, in a pause, (not a skip) with the prospect of two more
hikes possible before the end of the year. The ECB increased rates by
25 basis points with more to come over the next few months. The Bank of
England MPC raised rates by 50 basis points to 5.00%. Markets are
convinced UK base rates may rise to 6% before the end of the year. That's a big call ...
Where
Are Rates Headed? Bet on Higher for Longer —Here and Everywhere …
prices and labour costs are weighing on central bankers despite fears of
instability in the U.S. regional banking sector and the prospects of
recession in Europe and the U.K. So what happens next ... this is our latest "Friday Forward Guidance". It could be a soft landing in the U.S. In the U.K. six month gilts look over bought ...
Fed Funds Rate ...
Inflation CPI eased to 3.0% in June
from 4.0% prior month. Producer price inflation eased back to 0.1%
from 0.9%. The Fed increased rates by 25 basis points at the May
meeting but skipped the rate rise in June. The target range for the Fed funds rate was held at 5.00% to 5.25%.
Doves
will be pleased by the latest data. Hawks will remain concerned. Core
inflation, (all items less food and energy) remained high at 4.8%,
albeit down from prior month's 5.3%. Food inflation was 5.7%. A 17% drop
in energy prices flattered the overall data.
The median
projection for the appropriate level of the federal funds rate is now
considered to be just 5.5 percent in 2023 easing to 4.5% in 2024. Markets
assume the Fed rate hike cycle may be "close to being over". The Fed
blue dot forecasts suggest there could be two further rate rises this
year with no cuts in prospect until 2024.
The
Fed June forecasts assume growth of 1.0% this year increasing to 1.1%
in 2024. Growth in the first quarter was revised upwards to 1.8% year on
year in the latest BEA release. Forecasts for unemployment have been
reduced. PCE inflation is expected to slow to 3.2% this year and 2.5%
next.
We model U.S. base rates peaking at
5.5% in 2023 moving to 4.50% in 2024. The Fed Blue Dot forecasts suggest
the Long Run average rate in the U.S is now 2.50%. Our model rate is
around the 4.50% level.
The US curve remains inverted. Two year U.S. treasuries trade at 4.66 (5.00). U.S. ten year bond yields are trading at 3.79 from 4.06. US, 30 year rates trade at 3.91% from 4.01%.
This
is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the
flight, don't buy a return, we think this is a one way trip. |
| | Bank Base Rate...
Inflation,
CPI was unchanged at 8.7% in May from 8.7% in April. Inflation may have
peaked in October but inflation remains "sticky"" with food inflation
running at over 17%. Core inflation, increased to 7.1% from 6.8%.
Producer
Prices are moving in the right direction. Input prices eased to 2.4% in
May from 5.2% in April, output prices moved to 2.9% from 5.2% prior
month. The June inflation update will be released on Wednesday next
week.
The MPC has been spooked by the
latest data on inflation and earnings. Earnings increased by 7.4% in
May. The latest 6% guarantees on public sector pay will continue to
alarm the hawks.
At
its meeting ending on 21 June 2023, the MPC voted by a majority of 7–2
to increase Bank Rate by 50 basis points to 5.00%. Two members Swati
Dhingra and Silvana Tenreyro voted to maintain Bank Rate at 4.50%.
The
MPC’s updated projections showed CPI inflation falling back sharply
from the elevated level, of 10.5% in December. Annual CPI inflation was
expected to fall to around 5% towards the end of this year.
Looking
further ahead, the MPC stated it will adjust Bank Rate as necessary to
return inflation to the 2% target sustainably in the medium term, in
line with its remit. Markets appear convinced rates may peak at 6.00% before the end of the year.
Three month gilts trade at 5.4% from 5.4%. Six month gilt yields trade at 5.8% unchanged in the week. UK two years offer 5.1% down from (5.5%), UK ten year gilt yields are trading at 4.40% from 4.70%. UK 30 year rates are at 4.54 from 4.48.
For
the moment we are adjusting our base rate peak this year to 5.5% on the
basis of two 25 basis point hikes in August and September.
We model 4.50% as the long run rate for base rates and ten year gilts in life after Planet ZIRP.*
The latest monthly GDP estimates suggests the UK expanded by just 0.2% in the second quarter compared to 0.5% in Q1.
* Long Term Note : In
the UK, prior to the Great Financial Crash [2000 - 2008] the average
inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year
bond yields averaged 4.50%. |
| Want to know more ...
Stay
up to date with our Friday Forward Guidance Features on Rates and our
Monday Morning Markets updates on equities, bond yields, exchange rates,
and commodity prices. Available on The Saturday Economist web site. We also cover European rates on the site ...
Have a great weekend,
John |
| | To understand the markets, you have to understand the economics ... and we do
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