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Friday 28th January 2022
Hi Friend,
Friday Forward Guidance ...
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| | The Saturday Economist Friday Forward Guidance ... This is our Friday Forward Guidance for Friday 28th January. Every week we update our scenario forecasts for base rates in the U.S. UK and Europe over a three year period. We also include our expectations for inflation, as an input to the central bank reaction function, in the Saturday Economist updates.
Our outlook is pretty much unchanged this week. The Fed statement this week confirmed the economy and the employment outlook continue to strengthen. Rates are set to rise. "With inflation well above 2%, the committee expects it will soon be appropriate to raise the target range for the fed funds rate". The first rate hike is expected in March, the first of four, or possibly five, rate increases this year.
Ten year bond yields moved higher in the week. U.S. ten year yields trade at 1.84 this morning up from 1.75 at close last week. UK gilts ten years trade at 1.26 up ten basis points. The big move is expected once the Fed purchases end in March. US:UK spreads should tighten.
U.S. equities slipped. Sterling moved lower against the Dollar. Bitcoin trades at $36,000 dollars as we write. Don't miss The Saturday Economist out tomorrow. We talk about the IMF update on world growth. Don't miss Our Monday Morning Markets, out on Monday.. We review the equity sell off and bond yield rise this week.
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| | Fed Funds Rate ...
The Fed statement this week confirmed the economy and the employment outlook continue to strengthen. "The committee expects it will soon be appropriate to raise the target range for the fed funds rate". The first hike expected in March. Forward contracts January 2023 are trading with an implied yield of 1.21%.
Markets are braced for four or possibly five rate hikes this year. Markets slipped. NASDAQ down 4%. The S&P down 3%. The Dow down 2%. The adjusted discount rate would imply a 4% adjustment.
Ten year bond yields trade at 1.84 this morning. Next the test of 2.00 and 2.50. We expect the bigger moves once the Fed stops buying in March.
We expect four base rate hikes from end of Q1 onward, rising to 2.50% by the end of
2025. US rates would end the year at 1.00%. The projections remain broadly in line with the FOMC December
Blue Dot Plot. This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't forget the cancellation insurance.
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| Fed Funds Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 1.00% 1.50% 2.00% 2.50% 3.50%
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| | Bank Base Rate...
All eyes on the MPC next week. The first meeting of the new year. No clues as to next action. Members have been silent on the timing of the next move for UK rates.
The IMF downgraded the forecasts for UK growth this year. Uncertainty persists as to the Omicron overhang into the New Year. The MPC may decide to hold rates until the later meeting on March 23rd. The FOMC meets on the 16th/17th March. Would be neat!
Ten year gilts trade at 1.26 up ten basis points. Next the test of 1.50 then 2.00. Sterling trades lower against the Dollar at $1.34. So what of base rates? The market-implied path for Bank Rate hits 1.1% by the end of 2022. We assume the pattern of rate hikes, will hold in line with US Fed
policy, to close at 1.00% in the final quarter. We expect more to follow in 2023, pushing to 1.50 at close. The MPC should commit to the great escape from Planet ZIRP.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 1.0% 1.50% 1.75% 2.50% 3.50%
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| | Euro Base Rate...
The IMF downgraded the forecasts for Euro area growth this year to 3.9% from 4.3% expected in October. Christine Lagarde, President
of the EU Central Bank has suggested European rates could stay on
hold through 2022.
Lagarde rejected calls to raise rates more quickly than planned. the bank had "every reason not to act as quickly or as ruthlessly as the Federal Reserve". Rising rates too quickly would "put the brakes on growth" she said.
IMF and China caution on excessive moves from the Fed. Lagarde should be cautious of a reluctance to move in Europe. The Euro trades at $1.11 against the Dollar down from $1.13 in the week.
If our expectations for US
and UK rates hold, we would Euro rates could close at 0.25% by the end
of 2022 at least, to avoid significant pressure on the Euro. It could well be higher closing at 0.50%.
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| ECB Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.00% 0.25% 0.50% 0.75% 2.50% 3.50%
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| | | Scenario Comparisons ...
This is the table of scenario comparisons. We would expect UK rates to lag not lead the US pattern. EU rates would follow the US/UK lead. Inflation may subside sooner than expected. Central banks may worry about the shock to growth. Russia may step over the border into Ukraine. The escape from Planet ZIRP could be aborted. This is a scenario not the plan.
Our modified Taylor rule suggests the UK central bank is behind the curve on rate hikes. In our modified Taylor rule we model base rates as a function of inflation variance from target and the output gap relative to trend growth. The implication is base rates should close the year at 1.25% in 2021 and by 1.50% by the end of 2022. This is a benchmark not a forecast!
We model the long run rate at 3.50%. The Fed Blue dot projections assume 2.50% as the perceived long run rate. 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%. Some way to go yet!
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| | That's all for this week's Friday Forward Guidance. Don't miss the Saturday Economist Out Tomorrow ... and our Monday Morning Markets out on Monday ...
John
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© 2022 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
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