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Friday 18th 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 18th 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.
The Federal Reserve announced a 25 basis points increase this week. A further six rate hikes could follow this year, with three more rate hikes in 2023. The Bank of England also announced a 25 basis point increase. UK base rate increased to 0.75%. "Some further modest tightening in monetary policy may be appropriate in the coming months", the MPC suggests.
We think US base rates could end the year at 2.00%. In the UK, the market-implied path for bank rate suggests 2.00% could also be the level achieved this year. For the moment we remain slightly more cautious. The MPC March vote was not unanimous. The vote was 8 to 1. We think 1.50% may be the upper limit by Q4. Either way, the range is set.
U.S. ten year bond yields are trading at 2.15 this morning. UK ten year gilt yields are trading at 1.50. Our first level targets achieved. Next we call 2.50 and 2.00 by the end of the year, the U.S., U.K split with a 50 point spread. We have also upgraded our expectations for Euro rates, in view of the substantial rate hikes planned by the Fed and the Bank of England.
Oil trades at $108.14 Brent Crude as we write, down $4 dollars in the week. Sterling trades up against the Dollar at $1.3143. Don't miss The Saturday Economist out tomorrow. We begin to grapple with the outlook for growth in the UK and around the world.
Don't miss Our Monday Morning Markets, out on Monday. We reckon US markets remain some 5% over extended ... European stocks offer fair value. Asian markets, China and Hong Kong over sold by some 10%.
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| | Fed Funds Rate ...
Inflation CPE hit 7.9% in February. As expected the FOMC increased rates by 25 basis points in March. The Fed signaled six more rate hikes this year and a possible three increases next.
We model U.S. base rates at 2.00% by the end of the year, closing at 2.50% by the final quarter of 2023. The Fed forecast is slightly more hawkish, at 2.75% by Q4 next year.
Forecasts for growth this year have been slashed from 4% to 2.8% by the Fed. Projections for growth in 2023 are unchanged at 2.2%. Inflation CPE is expected to end the year at 4.3% slowing to 2.7% by the end of the following year.
Ten year bond yields trade at 2.15 this morning. Our first target level achieved. We model ten year bond yields rising to 2.50% by the end of the year, increasing to 3.00% by the end of 2023.
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% 2.00% 2.50% 2.50% 2.50% 3.50%
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| | Bank Base Rate...
Inflation, CPI hit 5.5% in January. It is expected to increase to around 5.9% in February before peaking at almost 9% in the second quarter.
As expected, the Bank of England increased rates by 25 basis points this week. We expect rates to end the year at 1.50% and 2.00% by the end of 2023.
The market-implied path for bank rate suggests 2.00% could be the level achieved this year. For the moment we remain slightly more cautious. The March hike was not a unanimous decision. The bank view "some further modest tightening may be appropriate in the coming months".
Ten year gilts trade at 1.50 this morning for a 2 point loss. We expect 10 year gilt rates to trade at 2.00 by the end of the year and 2.50 by the end of 2023. Sterling trades against the Dollar at $1.3143 this morning.
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| Bank Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.25% 1.50% 2.00% 2.00% 2.50% 3.50%
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| | Euro Base Rate...
Inflation in the Euro Zone hit 5.9% in February, up from 5.1% in January. The latest statement from the ECB was more hawkish than expected in March. 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.
If our expectations for US
and UK rates hold, Euro rates could close at 0.50% by the end
of 2022, rising to 1.00% at the end of 2023. The Euro trades at $1.1049 against the Dollar, a good rally in the week, faded at close. |
| ECB Base Rate 2021 2022 2023 2024 2025 Long Run Rate
Q4 0.00% 0.50% 1.00% 1.50% 1.75% 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 ...
John
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