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Friday 18th 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 18th 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 remains unchanged this week. However it seems probable our end of year base rate forecasts for the U.S. and the U.K. will be upgraded to 1.50% quite soon.
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. Markets now expect rates to rise by 50 basis points in March. Fed swaps show a full 100 basis point rise on the cards, over the next three meetings.
Ethan Harris, Head of Global Economics a Bank of America, now expects seven rate hikes this year. His year end target is 1.85% with two increases possible in 2023. Inflation is set to end the year at around 3% with more aggressive Fed action.
U.S. ten year yields slipped this week, trading at 1.97%, down 5 points. UK ten year bond yields also moved lower, trading at 1.44%, for an eight basis point loss. We still expect the big U.S. move expected once the Fed purchases end in March. 2.00 and 1.50 our short term target U.S./U.K split with a 50 point spread.
U.S. equities were in the red yesterday but rallied this morning. Sterling moved higher against the Dollar. Bitcoin trades at $40,600 dollars as we write. Don't miss The Saturday Economist out tomorrow. We report on the latest jobs and inflation data. Don't miss Our Monday Morning Markets, out on Monday. We reckon US markets remain some 10% 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. Markets now expect a 50 point move in in March. James Bullard, St Louis Fed Chair said "I would like to see 100 basis points in the bag by July 1st". This week he cautioned "inflation could become a more serious problem, without strong central bank intervention".
FOMC minutes suggest the Fed is signalling an openness to faster rate increases to curb inflation.
U.S. ten year bonds slipped below the 2.00 level this week. Rallying soon, 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.
Markets moved lower yesterday but rallied this morning. 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. 1.50% by the end of the year is our more hawkish scenario. 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 inflation CPI basis increased to 5.5% in January. Goods inflation increased to 7.2%. Producer prices were up by almost 10%. The Bank expects CPI inflation to hit 7% in April as energy caps adjust. Oil Brent Crude, trades lower this morning at $90.78. We talk about inflation and the Labour Market in greater detail in tomorrow's edition of The Saturday Economist.
It seems clear rates will rise by a further 25 point move in March. Some expect a 50 point move. This would be at odds with the Governor's slow and steady approach. We expect rates to end the year at 1.25% but may upgrade to 1.50% soon.
Ten year gilts trade at 1.44 this morning for an eight point loss points. Next the return to 1.50 and the test of 2.00. Sterling trades against the Dollar at $1.3616. 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. Watch out for that 1.50% call by end of year
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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. Inflation in Europe, is expected to fall to 2% by end of year.
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 $1.1360 against the Dollar down from $1.1387 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 ...
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"To understand the markets, you have to understand the economics"
John
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