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Friday 11th March 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 March. 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 forecasts are unchanged once again this week. We expect base rates in the U.S. and the U.K. to rise to 1.50% by the end of the year, increasing to at least 1.75% to 2.00% in 2023. We also expect EU base rates to rise by the end of the year, following the latest statement from Christine Lagarde, President of the ECB.
Analysts have been dialing down their expectations for base rate hikes this year. Central banks are grappling with the prospect of lower growth, higher inflation and greater market volatility. Inflation jumped to 7.9% in the US in February. EU Inflation hit 5.8%. The latest update for UK CPI is due next week. January's jump point was 5.5%.
It seems clear the Fed, the ECB and the Bank of England will continue to adopt a tighter monetary stance despite the inflation surge. Bond yields rallied following last week's slump.
U.S. ten year yields are trading at 1.99 this morning. UK ten year bond yields are trading at 1.52. The flight to safety was just a short hop with a return ticket. We expect the big U.S. move once the Fed purchases end in March. 2.00 and 1.50 is our short term target, next 2.50 and 2.00, the U.S., U.K split with a 50 point spread.
Oil trades at $111 Brent Crude this morning, unchanged in the week. Sterling trades lower against the Dollar at $1.31. Don't miss The Saturday Economist out tomorrow. We try to make sense of the madness in the East. Our third in our Russian series is "Putin In Perspective ... the real fears about NATO".
Don't miss Our Monday Morning Markets, out on Monday. We reckon US markets remain some 5% over extended ... European stocks and Asian markets look over sold by an average 5%, 10% the damage in France and Germany.
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| | Fed Funds Rate ...
Markets now expect a 25 - 50 point move in March. Concerns are growing about higher inflation, lower growth and greater market volatility. The latest payroll data will assuage fears about growth, the latest inflation data will augment fears of inflation.
Growth may slow from the 4.4% forecast at the end of the year. Inflation may peak at 10% in the months ahead and linger longer to the end of the year.
We model the 50 point hike next month, with four further increases through to the end of the year; 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.
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| Fed Funds Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.10% 1.50% 1.75% 2.00% 2.50% 3.50%
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| | Bank Base Rate...
Inflation data for February is eagerly awaited next week. The latest January figure of 5.5% is expected to yield to around 5.9% before peaking at almost 9% in the second quarter.
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% to 2.00% in 2023.
Ten year gilts trade at 1.52 this morning for a 24 point gain. Next the return to 1.50 and the test of 2.00 we said. Sterling trades against the Dollar at $1.31 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% to 2.00% at close. The MPC is committed to the great escape from Planet ZIRP despite the surge in energy and commodity costs.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 1.50% 1.75% 2.00% 2.50% 3.50%
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| | Euro Base Rate...
Inflation in the Euro Zone hit 5.8% in February, up from 5.1% in January. The statement from the ECB was more hawkish than expected this week. QE purchases are to be trimmed into the second quarter and could end in Q3.
"Interest rate rises would follow shortly after the end of bond buying" said Lagarde. This would leave open the possibility of at least one rate rise before the end of the year.
The Euro trades at $1.0978 against the Dollar, pretty much unchanged in the week. If our expectations for US
and UK rates hold, 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, despite increasing inflation. 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!
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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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