Today’s topic has become something of a hot subject as 2022 has begun. Some of you may recall that it was to some extent as 2021 opened but there was a difference as back then bond yields were rising but central banks had no intention of raising interest-rates. Indeed there were times we feared further cuts in them. This time around the mood music is different and we can start with the man who is the most important in this regard which is Jerome Powell of the US Federal Reserve. Yesterday he gave testimony to Congress as part of his appointment for a second term.So he is personally in a stronger position than the days when President Trump was second-guessing him and indeed suggesting policy.
The nub of the discussions is summarised by Barron’s below.
Inflationary pressures are expected to last well into the middle of this year, but the Federal Reserve is prepared to act if they last longer than expected, Fed Chairman Jerome Powell said Tuesday during his renomination hearing.
“If we see inflation persisting at high levels longer than expected, if we have to raise interest rates more over time, then we will,” Powell said Tuesday.
There is an interesting use of the word more there as so far he has not raised them at all. What he is referring to is the hints in for example the dot plot forecasts that they will. These days central bankers live in a world where they think people hang on their every word and that it makes a difference if they forecast 3 interest-rate rises rather than 2.Of course Wall Street does but Main Street is mostly not even aware of it. Actually considering how often the central banking forecasts are wrong the latter bit is usually for the best.
We can stick with the issue of him being wrong as the analysis goes on.
For financial markets, a key area to watch beyond timing of the first interest-rate hike is Powell’s remarks concerning his future inflation expectations. The Fed chief indicated that although inflation will continue for a few months, he was optimistic supply-chain bottlenecks would ease and inflation would subside “over time.”
He has been consistently wrong on this issue as the whole “Transitory” concept indicates. It should now be fading whereas forecasts for today’s CPI release suggest it may reach 7%. Whether it does or does not the problem is that it has gone much higher than the Federal Reserve suggested and lasted longer.
How Much Will They Rise?
Reuters suggested this.
If prices continue spiking, the Fed could be forced to push through a sharper rise in interest rates this year than the three quarter-percentage-point hikes its policymakers currently anticipate, risking a return to recession.
So they are singing along with De La Soul.
Three
That’s a magic number
For some three’s a crowd and they prefer two.
Fitch Ratings-London-11 January 2022: Fitch Ratings expects the Fed to raise rates twice in 2022 and four times in 2023, taking the Fed funds rate (upper bound) to 1.75% by end-2023 from 0.25% currently. Fitch’s updated US interest rate forecasts reflect the major pivot by the Fed at its policy meeting on 14-15 December 2021, prompted by evidence that inflation is broadening and underscored by the meeting minutes.
An alternative argument is made for four.
Goldman Sachs | Funds Rate Set to Rise Well Above Market Pricing We continue to see hikes in March, June, and September and have now added a hike in December for a total of four in 2022. Our forecast for the terminal funds rate remains 2½-2¾%.
Bond Yields
There has been a change here as this time last year the US ten-year yield was 1.09% as opposed to the 1.75% as I type this. Actually we also reached this level on the first of April 2021 which proved to be something of an April Fool for those long bonds.
Another way of looking at this is that the move is not that much in the circumstances. After all inflation is already over 6% and may reach 7% so in terms of the yield above we are looking at four years worth.
Putting it another way at the present rate then using yield your ten-year bond will require all of its term to just cover this year’s rise in house prices.
The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 19.1% annual gain in October, down from 19.7% in the previous month.
So we are to an extent looking at a move in the foothills rather than the mountains.
Other Central Banks
There will be a variety of moves elsewhere. For some the move will be automatic such as Hong Kong if it wishes to retain a US Dollar exchange-rate peg.Others will be tugged along in an implied form such as my subject of yesterday, Argentina, and Turkey via their borrowing in US Dollars which will be influenced by US interest-rate moves.
For others the situation is more complex but at the simpler end I expect to find the Bank of Canada. I realise that it does not know that yet! As its policy statements came before the change in view at the US Federal Reserve. I also expect the Bank of England to make some sort of move. However there are much more constraints at the ECB and the Bank of Japan who may not move at all. One possibility is that the Bank of Japan will make a symbolic move to 0% so a mere 0.1% rise.
There is another category of central bank that is not waiting for the US Fed at all including some in Eastern Europe. Here is the Czech Republic.
The CNB Bank Board increased the two-week repo rate (2W repo rate) by one percentage point to 3.75%. At the same time, it increased the discount rate by the same amount to 2.75% and the Lombard rate to 4.75%.
In one go on the 22nd of December they did more than the US Federal Reserve is forecasting for the whole of 2022.
Comment
Having looked at what is generally expected let me now add in my longstanding view which goes as follows. There is a clear assymetry between the criteria for an interest-rate cut and a rise. The former can be that day as we saw around March 19th 2020 whereas the latter is in the post and may or may not arrive. If inflation was as below the target as it is now above we would have seen US interest-rate cuts and I would be analysing the impact of negative interest-rates there. Whereas for a rise we are so far singing along with Bob Marley.
‘Cause if summer is here
I’m still waiting there
Winter is here
And I’m still waiting there
Let me now take that further. We will probably get an interest-rate rise or two because the momentum is now there. That has the problem that if they really believed in more than the first bit of the statement below they would already have done so.
The Fed typically lowers interest rates to boost demand and spur growth, and raises them to slow down an overheating economy. ( Barrons )
But at any real sign of a reverse for the economy they will turn tail and start cutting interest-rates. So whilst it may not be that likely that 2022 will end with the US seeing negative interest-rates it is far from impossible.