Friday Forward Guidance ...
This is our Friday Forward Guidance for Friday 26th May. 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.
This month, the Fed hiked by 25 points, the ECB increased base rates by 25 basis points. The Bank of England followed with a 25 point rate hike to 4.5%. Where Are Rates Headed? Bet on Higher for Longer —Here and Everywhere … prices and labour costs are weighing on central bankers in the U.S. and the U.K despite fears of instability in the U.S. regional banking sector.
Markets would like to think the rate hikes are over in the US. for this current stage of the cycle. Rates are set at 5.00% to 5.25%. In the UK rates may peak at 4.50% to 4.75%. Markets were spooked this week by the latest U.K. inflation data. Traders appear certain Threadneedle Street will raise interest rates at the Bank's next three meetings in June, August and September. Two year yields jumped to 4.5%.
Suggestions base rates may rise to over 5% appear overplayed. More hiking is set to follow in Europe, the marginal lending rate may have to rise to 4.5%.
U.S. ten year bond yields are trading at 3.83 this morning from 3.62 last week. UK ten year gilt yields are trading at 4.36 from 3.95. The US curve is inverted. Two year U.S. treasuries trade at 4.58 (4.22), UK two years offer 4.51 up from (3.95). Expect yields to rise further, we said last week and they have.
In the US, 30 year rates trade below the 4% level, trading at 3.99 (3.90). UK 30 year rates are at 4.67 from 4.39 ...
This month, the Fed hiked by 25 points, the ECB increased base rates by 25 basis points. The Bank of England followed with a 25 point rate hike to 4.5%. Where Are Rates Headed? Bet on Higher for Longer —Here and Everywhere … prices and labour costs are weighing on central bankers in the U.S. and the U.K despite fears of instability in the U.S. regional banking sector.
Markets would like to think the rate hikes are over in the US. for this current stage of the cycle. Rates are set at 5.00% to 5.25%. In the UK rates may peak at 4.50% to 4.75%. Markets were spooked this week by the latest U.K. inflation data. Traders appear certain Threadneedle Street will raise interest rates at the Bank's next three meetings in June, August and September. Two year yields jumped to 4.5%.
Suggestions base rates may rise to over 5% appear overplayed. More hiking is set to follow in Europe, the marginal lending rate may have to rise to 4.5%.
U.S. ten year bond yields are trading at 3.83 this morning from 3.62 last week. UK ten year gilt yields are trading at 4.36 from 3.95. The US curve is inverted. Two year U.S. treasuries trade at 4.58 (4.22), UK two years offer 4.51 up from (3.95). Expect yields to rise further, we said last week and they have.
In the US, 30 year rates trade below the 4% level, trading at 3.99 (3.90). UK 30 year rates are at 4.67 from 4.39 ...
Fed Funds Rate ...
Inflation CPI eased to 4.9% in April from 5.0% prior month. Producer price inflation eased back to 2.3% from 2.7%. The Fed increased rates by 25 basis points at the May meeting. The target range for the Fed funds rate increased to 5.00% to 5.25%.
The median projection for the appropriate level of the federal funds rate is now considered to be just over 5 percent in 2023 easing to 4.3% in 2024. Markets assume the Fed rate hike cycle may be over for now. The Fed are suggesting no rate cuts are in prospect in 2023.
The market has repriced the outlook for Fed policy. Two weeks ago they were looking at rates having peaked and a first 25bp rate cut coming in September with nearly 100bp of cuts by the January 2024 FOMC meeting. Now there is a 30% chance of a 25bp hike and a 65% chance by the July FOMC meeting. Cuts are still priced before year end, but no-where near to the same extent.
We model U.S. base rates peaking at 5% in 2023 moving to 4.50% in 2024. The Fed Blue Dot forecasts suggest the Long Run average rate in the U.S is now 2.50%. Our model rate is around the 4.5% level.
This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't forget the cancellation insurance. The Fed may yet lose the plot.
Inflation CPI eased to 4.9% in April from 5.0% prior month. Producer price inflation eased back to 2.3% from 2.7%. The Fed increased rates by 25 basis points at the May meeting. The target range for the Fed funds rate increased to 5.00% to 5.25%.
The median projection for the appropriate level of the federal funds rate is now considered to be just over 5 percent in 2023 easing to 4.3% in 2024. Markets assume the Fed rate hike cycle may be over for now. The Fed are suggesting no rate cuts are in prospect in 2023.
The market has repriced the outlook for Fed policy. Two weeks ago they were looking at rates having peaked and a first 25bp rate cut coming in September with nearly 100bp of cuts by the January 2024 FOMC meeting. Now there is a 30% chance of a 25bp hike and a 65% chance by the July FOMC meeting. Cuts are still priced before year end, but no-where near to the same extent.
We model U.S. base rates peaking at 5% in 2023 moving to 4.50% in 2024. The Fed Blue Dot forecasts suggest the Long Run average rate in the U.S is now 2.50%. Our model rate is around the 4.5% level.
This is our "We are leaving Planet ZIRP" scenario. Grab a ticket for the flight, don't forget the cancellation insurance. The Fed may yet lose the plot.
Bank Base Rate...
Inflation, CPI eased to 8.7% in April from 10.1% in March. Inflation may have peaked in October but inflation remains "sticky"" with food inflation running at over 19%. Producer Prices are moving in the right direction. Input prices eased to 5.7% in April from 8.5% in March, output prices moved to 5.4% from 8.7% prior month.
At its meeting ending on 11 May 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.25 percentage points, to 4.50%. Two members Swati Dhingra and Silvana Tenreyro voted to maintain Bank Rate at 4.25%.
"Headline CPI inflation has begun to edge back and is likely to fall sharply over the rest of the year as a result of past movements in energy and other goods prices. However, the labour market remains tight and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation. Food inflation remains stubbornly high."
The MPC’s updated projections showed CPI inflation falling back sharply from thy elevated level, of 10.5% in December. Annual CPI inflation was expected to fall to around 5% towards the end of this year. The UK is now expected to avoid recession in the current year.
Looking further ahead, the MPC stated it will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.
We model 4.00% as the long run rate in life after Planet ZIRP but 4.50% may yet be a possibility.
NIESR are now forecasting growth of 0.2% this year. The EY ITEM club are also forecasting growth of 0.2% in 2023, increasing to 1.9% on 2024. The IMF, now not so gloomy, expect the U.K. to avoid recession this year with growth of around 0.4%. Growth in the first quarter of the year is likely to be around 0.4% .
We expect rates to peak at 4.5% or possibly 4.75% this year before easing back to around 4% into 2024 ... assuming inflation moderates as expected ...
Inflation, CPI eased to 8.7% in April from 10.1% in March. Inflation may have peaked in October but inflation remains "sticky"" with food inflation running at over 19%. Producer Prices are moving in the right direction. Input prices eased to 5.7% in April from 8.5% in March, output prices moved to 5.4% from 8.7% prior month.
At its meeting ending on 11 May 2023, the MPC voted by a majority of 7–2 to increase Bank Rate by 0.25 percentage points, to 4.50%. Two members Swati Dhingra and Silvana Tenreyro voted to maintain Bank Rate at 4.25%.
"Headline CPI inflation has begun to edge back and is likely to fall sharply over the rest of the year as a result of past movements in energy and other goods prices. However, the labour market remains tight and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation. Food inflation remains stubbornly high."
The MPC’s updated projections showed CPI inflation falling back sharply from thy elevated level, of 10.5% in December. Annual CPI inflation was expected to fall to around 5% towards the end of this year. The UK is now expected to avoid recession in the current year.
Looking further ahead, the MPC stated it will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.
We model 4.00% as the long run rate in life after Planet ZIRP but 4.50% may yet be a possibility.
NIESR are now forecasting growth of 0.2% this year. The EY ITEM club are also forecasting growth of 0.2% in 2023, increasing to 1.9% on 2024. The IMF, now not so gloomy, expect the U.K. to avoid recession this year with growth of around 0.4%. Growth in the first quarter of the year is likely to be around 0.4% .
We expect rates to peak at 4.5% or possibly 4.75% this year before easing back to around 4% into 2024 ... assuming inflation moderates as expected ...
Euro Base Rate...
Euro area annual inflation eased to 8.3% in March 2022, down from 9.9% in February, according to latest data from Eurostat, the statistical office of the European Union. The Euro area grew by 3.6% in 2022, growth in the first quarter is estimated at 1.3%. Growth is now expected to be just over 1% in the current year, rising to 1.6% in 2024 and 2025.
At the May meeting, the Governing Council decided to raise the three key ECB interest rates by 25 basis points.
"The inflation outlook continues to be too high for too long. In light of the ongoing high inflation pressures, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points. Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous meeting. Headline inflation has declined over recent months, but underlying price pressures remain strong.
Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 3.75%, 4.00% and 3.25% respectively, with effect from 10 May 2023."
The Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target.
The markets assume the ECB vows more hhiking t
Previously we have said, "If our expectations for US and UK rates hold, Euro rates (marginal lending facility basis) could rise to 3.75% in the second quarter and close at that level at the end of 2023. This would still mean Euro rates are lagging U.S. and U.K. rates significantly, suggesting pressure on the Euro will continue, or the ECB will move more aggressively to narrow the rate gap. We expect upward revisions to the European rates outlook are possible despite fears of recession and inflation easing. We now expect rates to peak at 4.25% in the second quarter.
Euro area annual inflation eased to 8.3% in March 2022, down from 9.9% in February, according to latest data from Eurostat, the statistical office of the European Union. The Euro area grew by 3.6% in 2022, growth in the first quarter is estimated at 1.3%. Growth is now expected to be just over 1% in the current year, rising to 1.6% in 2024 and 2025.
At the May meeting, the Governing Council decided to raise the three key ECB interest rates by 25 basis points.
"The inflation outlook continues to be too high for too long. In light of the ongoing high inflation pressures, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points. Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous meeting. Headline inflation has declined over recent months, but underlying price pressures remain strong.
Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 3.75%, 4.00% and 3.25% respectively, with effect from 10 May 2023."
The Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target.
The markets assume the ECB vows more hhiking t
Previously we have said, "If our expectations for US and UK rates hold, Euro rates (marginal lending facility basis) could rise to 3.75% in the second quarter and close at that level at the end of 2023. This would still mean Euro rates are lagging U.S. and U.K. rates significantly, suggesting pressure on the Euro will continue, or the ECB will move more aggressively to narrow the rate gap. We expect upward revisions to the European rates outlook are possible despite fears of recession and inflation easing. We now expect rates to peak at 4.25% in the second quarter.
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. 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 4.0%. The Fed Blue dot projections assume 3.50% 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, in the return to normality!
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. 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 4.0%. The Fed Blue dot projections assume 3.50% 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, in the return to normality!
That's all for this week ... "to understand the markets you have to understand the economics" and we do ...
© 2023 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.
© 2023 John Ashcroft, Economics, Strategy and Financial Markets, experience worth sharing.