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Friday 11th February 2022
Hi Friend,
Friday Forward Guidance ...
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| | | The Saturday Economist Friday Forward Guidance ... This is our Friday Forward Guidance for Friday 11th February. 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 unchanged this week. We are braced for the changes this year, or so we think. The hawks take flight. Markets are adjusting flight plans. We really are leaving Planet ZIRP. Jim O'Neill thinks base rate levels are at a ridiculous level. "The Bank of England should be setting a goal of base rates at 4%". Jim''s a hawk!
In the U.S., Fed Bank of Louis Chair James Bullard, said he supported raising rates by a full 100 points by July. Latest U.S. CPI inflation data hit 7.5% in January. Markets expect (50:50) rates to rise by 25 or 50 basis points in March. Fed swaps show a full 100 basis point rise on the cards, over the next three meetings.
U.S. ten year yields jumped, trading at 2.02% up 21 points. UK ten year bond yields moved higher, trading at 1.52%, for a fifteen basis point gain. The big U.S. move expected once the Fed purchases end in March, our short term targets, in the our Bond Market Sentinel last Monday, are already blown away.
U.S. equities were in the red yesterday. Sterling moved higher against the Dollar. Bitcoin trades at $43,000 dollars as we write. Don't miss The Saturday Economist out tomorrow. We report on the latest UK growth figures up 7.5% in the year. Don't miss Our Monday Morning Markets, out on Monday. We reckon US markets remain some 15% over extended ... More Pain to Come as discount rates rise and earnings growth slow? ... For Sure!
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| | Fed Funds Rate ...
Inflation CPI basis hit 7.5% in January. The hawks take flight. Markets are split 50:50 for a 25 or 50 basis point hike in March. James Bullard, St Louis Fed Chair said "I would like to see 100 basis points in the bag by July 1st". In an interview with Bloomberg news on Thursday he added, "I was already more hawkish but I have pulled up dramatically in terms of what I think the committee should do."
U.S. ten year bonds jumped over twenty basis points to breakthrough the 2.00 level. Next the test of 2.50 by Easter seems assured.
We now expect a 50 point hike in March, with two or three possible increases through to the end of the year. The Fed funds rate will close at 1.25% on our more hawkish scenario.
Markets moved lower yesterday but we expect them to steady by the end of the week. The increase in 100 basis points in discount rate would call for a 4% downside in equity levels. Modest earnings growth this year would underpin prices, despite the implicit over valuations on our Monday Morning Markets review.
We expect three to four base rate hikes from end of Q1 onward, closing at 1.25%, rising to 2.50% by the end of
2025. 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% 1.25% 1.50% 2.00% 2.50% 3.50%
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| | Bank Base Rate...
UK growth is recorded at 7.5% in 2021. No real surprise to readers of The Saturday Economist. We will talk about this more in our update tomorrow. Analysts are marking down their forecasts for growth this year. We will wait a few more weeks to revise our numbers if necessary.
Huw Pills Chief Economist at the Bank of England explained this week why he voted for a 25 basis point rise at the last MPC meeting. The Bank must raise rates slowly, to maintain credibility and avoid damaging the economy. "I worry that taking unusually large policy steps, may validate a market narrative that Bank policy is either foot-to-the-floor on the accelerator or foot-to-the-floor on the brake".
With this he is in step with the Governor, who prefers a step by step approach in rate rises avoiding any foot-in-the-mouth mistakes.
It seems clear rates will rise by a further 25 point move in March. We expect rates to end the year at 1.25%.
Ten year gilts trade at 1.52 up fifteen basis points. Next the test of 2.00. Sterling trades unchanged against the Dollar at $1.3552. The market-implied path for Bank Rate hits 1.25% by Q1 of 2023, then 1.50% by the middle of that year.
We assume the pattern of rate hikes, will close at 1.25% in the final quarter this year. We expect more to follow in 2023, pushing to 1.50% at close. It could be higher. The MPC is committed to the great escape from Planet ZIRP. Bond yields the beneficiary.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 1.25% 1.50% 1.75% 2.50% 3.50%
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| | Euro Base Rate...
Inflation in the Euro Zone hit 5.1% in January up from 5.0% in December. Christine Lagarde, President
of the EU Central Bank still suggests European rates could stay on
hold through 2022.
Lagarde warns, "raising interest rates would not solve any of the current problems, if we act too hastily now, the recovery of our economies could be considerably weaker and jobs could be jeopardized."
The Euro trades at $1.1387 against the Dollar down from $1.15 last 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%. The ECB cannot appear be too far out of step.
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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 ...
"To understand the markets, you have to understand the economics"
John
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