Subject: The Saturday Economist ... Friday Forward Guidance ... 😀

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                                                                                                     Friday 25th February 2022
Hi Friend,
Friday Forward Guidance ...
The Saturday Economist Friday Forward Guidance ...
This is our Friday Forward Guidance for Friday 25 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.
 
We have upgraded our forecasts for the US and UK base rates this week. We need to assess the impact of the Putin Putsch and the Central Bank reaction in due course. Oil, Brent crude, is trading at $99 dollars per barrel this morning. Gas prices are easing from mid week highs. Inflation fears are increasing. Markets are creaking. Concerns about growth may mitigate expected rate hikes.

We have upgraded our end of year base rate forecasts for the U.S. and the U.K. to 1.50% in 2022 and 1.75% in 2023.

In the U.S., JP Morgan Chase economists think the Federal Reserve is likely to raise interest rates by 25 basis points in nine consecutive meetings in a bit to tamp down inflation. This would take base rates to 2.25% by March next year.

Ethan Harris, Head of Global Economics at Bank of America, expects seven rate hikes this year. Goldman Sachs is also forecasting seven hikes this year. Their year end target is 1.85% with two increases possible in 2023.

U.S. ten year yields slipped, then rallied this week, trading at 1.95%, up one point. UK ten year bond yields also moved lower before ending higher trading at 1.42%, for a three point gain. We still expect the big U.S. move  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 lower against the Dollar at $1.34. Bitcoin trades at $38,300 dollars as we write. Don't miss The Saturday Economist out tomorrow. We report on the latest borrowing figures, PMI flash forecasts and some implications of Ukraine developments.

Don't miss Our Monday Morning Markets, out on Monday. We reckon US markets remain some 6% over extended ... European stocks look over sold ...
Fed Funds Rate ...
Markets now expect a 50 point move in March. JP Morgan economists think the Federal Reserve is likely to raise interest rates by 25 basis points in nine consecutive meetings in a bit to tamp down inflation. This would take base rates to over 2.00% by January next year.

U.S. ten year bonds slipped below the 2.00 level this week. Rallying to 1.95 this morning, the test of 2.50 by Easter seems assured.

Fed Governor Christopher Wallace laid out the case for a 50 point move in March. We now expect the 50 point hike next month, with four further 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 four base rate hikes from end of Q1 onward, closing at 1.50%, 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.
Fed Funds Rate                                 2021          2022         2023          2024          2025    Long Run Rate
Q4                                                       0.10%        1.50%       1.75%       2.00%        2.50%        3.50%
Bank Base Rate...
Sir Dave Ramsden, Bank of England deputy governor, expects interest rates will be raised by a modest amount over the coming months to curb rising inflation. The longer term path for monetary policy was difficult to predict he said. Uncertainty about energy prices, especially in light of the conflict between Russia and Ukraine, made it hard to look too far ahead. Dave Ramsden was speaking at The National Farmers’ Union annual conference in Birmingham.

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 1.50% and 1.75% in 2023.

Ten year gilts trade at 1.42 this morning for a three point gain. Next the return to 1.50 and the test of 2.00. Sterling trades against the Dollar at $1.3374 this morning. Tad over done! 

We assume the pattern of rate hikes, will close at 1.50% in the final quarter this year. We expect more to follow in 2023, pushing to 1.75% at close. It could be higher. The MPC is committed to the great escape from Planet ZIRP. Bond yields the beneficiary.
Bank Base Rate                                2021          2022         2023          2024          2025    Long Run Rate
Q4                                                      0.25%        1.50%         1.75%        2.00%        2.50%          3.50%
Euro Base Rate...
No real change here. 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.
As if ...

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 $1.1173 against the Dollar, down from $1.13607 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, despite problems in the east.
ECB Base Rate                                 2021          2022         2023          2024          2025    Long Run Rate
Q4                                                      0.00%        0.25%       0.50%       0.75%        2.50%       3.50%
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. 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.

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!
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
© 2022 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
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