Last October, an average of over USD 1,500 bn was traded daily on the Treasuries repo markets through the Fixed Income Clearing Corporation (FICC), USD 500 bn more than in October 2022. While transactions between FICC clearing members remained relatively stable, sponsored repo loans rose sharply.
Several central bankers have recently insisted that the ‘last mile’ in the marathon towards the inflation target may be the most challenging. After an initial swift decline of headline inflation on the back of favourable base effects due to lower energy prices, further disinflation may take more time. Corporate pricing power, inflation expectations and wage growth play a key role in this respect. By insisting on the ‘last mile’, central bankers probably want to avoid sounding too optimistic on disinflation. Otherwise, financial markets might price in early rate cuts, which would cause an easing of financial conditions in capital markets that would neutralize part of the monetary tightening
Updated GDP, inflation, interest and exchange rates data.
Monetary policy desynchronization between the Federal Reserve and the Bank of Japan (BoJ) has become huge. This has caused a significant weakening of the yen. Higher US yields have also exerted upward pressure on JGB yields, which in turn has forced a gradual adjustment of the BoJ yield curve control policy (YCC). Inflation developments in Japan increase the likelihood of a policy rate increase but policy normalization is a delicate task for domestic reasons as well as international spillovers. The BoJ has chosen a cautious approach, with very incremental steps, but in the meantime the yen has continued to weaken, creating the risk of a snapback once policy is tightened. Acting sooner rather than later seems to be the recommended route for the BoJ.
The tightening of euro-zone monetary policy, which began in July 2022 and carried on until September 2023, continued to curb demand for loans and dampen economic activity in the third quarter of 2023. The initial effects on core inflation have also been apparent since the end of the summer.
Data on GDP, inflation, interest and exchanges rates.
In the US and several European countries, gross public sector borrowing requirements are expected to remain sizeable and the reduction in the size of central banks’ balance sheets -quantitative tightening- complicates matters. The impact on bond yields will depend on the risk-bearing capacity of investors. Their ability and willingness to increase their exposure to duration risk depends on several factors: the existence or absence of strict duration risk limits in portfolios of institutional investors, risk aversion in reaction to recent bond yield volatility, uncertainty about the outlook for official interest rates, the correlation between bonds and equities, the balance sheet capacity of financial intermediaries
GDP growth, inflation, interest rates and exchange rates
In this series of two podcasts Andrew Craig, co-head of the Investments Insight Center at BNP Paribas Asset Management, interviewed William de Vijlder, group chief economist of the Economic Research of BNP Paribas regarding the central banks policies to fight inflation. Among the questions answered in the first episode are: Are we at the peak or can we expect further rates hikes? Is the inflation going to declines? at which pace?
In the second and last episode of the series on central banks and their fight against inflation, Andrew Craig and William de Vijlder are looking beyond the peak and discuss what will come next. Among the questions are: how long will central banks hold rates at these levels? How long will they plateau at these current levels? what come after that?
US Treasury yields have increased significantly since the end of July and this movement has accelerated in the past three weeks. It seems that the increase in the term premium has been a key driver although there is ambiguity about the underlying causes. There is no ambiguity however on the economic consequences: they are negative. A key channel of transmission is the housing market. Credit demand in general should suffer and another factor to monitor is the equity market considering that the earnings yield of the S&P500 is now lower than 10-year Treasury yields. All these factors represent a headwind to growth and may convince the FOMC that an additional rate hike before the end of the year is not warranted
PIB growth, inflation, interest and exchange rates
Elevated inflation has forced central banks across the globe to tighten monetary policy aggressively. When we look at the United States and at the Eurozone, we observe nevertheless that many hard data show a high degree of resilience.
The ECB has increased its key rates by 450 basis points since July 2022. This is the sharpest tightening of monetary policy since the creation of the euro area in 1999. This tightening has been transmitted to lending rates and bank deposit rates. This is in line with the objectives of monetary policy to slow global demand and to bring back inflation to a level of 2%.
In the world of central banking, nothing is what it seems. The ECB’s recent rate hike was considered dovish whereas the pause by the Federal Reserve received the label hawkish. These reactions show that, beyond the rate decision, the accompanying message also matters. That of the ECB was interpreted as signaling that the terminal rate had been reached. In the US, the latest rate projections of the FOMC members -the dot plot- point toward another hike before year end and a federal funds rate that would stay elevated for longer. This is unsurprising given the resilience of the US economy in reaction to the aggressive monetary tightening and the concern that bringing inflation back to the 2% target would take more time
GDP growth, inflation, interest and exchange rates.
In its latest meeting, the ECB Governing Council decided to tighten policy further, bringing the deposit rate to 4.00%. It considers that the current level of official rates, if maintained for a sufficiently long duration, will make a substantial contribution to bring inflation back to the 2% target in a timely way. Financial markets rallied, expressing a conviction that policy rates have reached their cyclical peak. The focus is now shifting to how long they will stay at this level and what will be the pace of easing thereafter. The ECB’s reaction function depends on the assessment of the inflation outlook in the light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission
In the coming quarters, economic growth in the United States and the Eurozone should slow down and core inflation should move significantly lower. Monetary policy works with long and variable lags, so part of the impact of higher rates still needs to manifest itself. This is taking more time than expected. It has been a long wait thus far. In the US, the economy in general has been particularly resilient although some data have softened as of late. In the Eurozone, the labour market remains strong, yet, many data have weakened, including in services. A factor that will also play a role in coming months are the developments in China where activity indicators published during the summer confirmed the rapid slowdown in growth
GDP growth, inflation, interest rates and exchange rates.
For economists and central bank watchers, the ECB conference in Sintra (Portugal) and the Federal Reserve conference in August in Jackson Hole are the highlights of the summer season. As always, the presentations and panels at the Sintra conference were very stimulating but also sobering. Disinflation is too slow, there are upside risks to inflation compared to the pre-pandemic era, policy rates will have to remain elevated and economic forecasting is more challenging than ever.
The interest rate projections (‘dots’) of the FOMC members represent a reference point that can help investors and economic agents in general in forming their own interest rate expectations This can be particularly welcome when the monetary environment is changing swiftly like has been the case over the past two years. To explore this, a comparison has been made between the federal funds rate projections of the Survey of Market Participants (SMP) and those of the FOMC members. It seems that the dots may play a role in anchoring long-term interest rate expectations. The private sector forecasts closely follow the dots for 2023 and to a lesser extent for 2024, beyond which they are essentially stable. This is important considering that it might influence the pricing of bonds
On 22 June, the Mexican Central Bank maintained its main policy rate at 11.25% for the second time in a row. The Governing Board’s decision was unanimous and largely anticipated. In its press release, the Board stated that the pause should continue over the coming months: the downward trend in inflation seems to be confirmed, but the outlook remains «complex and uncertain».
The significant and fast paced monetary tightening by major central banks and the prospect that more is to come raise the concern of a monetary ‘overkill’. This could happen due to a non-linear reaction of economic agents to an umpteenth rate increase. Several factors can play a role in this respect: negative animal spirits, debt levels and their characteristics, asset valuations, bank lending, capital markets. This calls for increased gradualism and, at some point, taking a pause whilst insisting that this doesn’t represent an end to the tightening cycle.
