Peak interest rates may be lower than expected as growth slowdown looms
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[May 27, 2022] By
Sujata Rao and Saikat Chatterjee
LONDON (Reuters) - Worsening economic data
may force central banks to blink and take a less aggressive rate-rise
stance, money markets are betting, having steadily dialled back
expectations of where U.S. and British interest rates might peak.
The equivalent of a half-point rate hike from the Federal Reserve has
been priced out over the last three weeks, putting the peak in rates at
3% next June.
That implies cumulative U.S. rate hikes of 210 basis points this cycle,
versus 255 bps at the start of May, according to Fed Fund futures that
reflect expectations of future interest rate moves.
In Britain too, despite expectations of 10% inflation this year,
recession signals are forcing a shift, with 120 bps of rate rises priced
until June 2023, from 165 bps at the start of May. That would take rates
to around 2.4%.
"What the market is doing now is focusing less on inflation and more on
the risk of recession, that's why we are seeing this repricing," said
Flavio Carpenzano, investment director at Capital Group.
"Markets also believe in the so-called Fed put, that when we get tighter
financial conditions and equity markets fall 20% the Fed will step in."
He was referring to the long-held belief that the U.S. central bank will
backstop falling stock markets by going easy on rate-tightening.
Global stocks have indeed perked up this week as money markets repriced,
snapping a seven-week falling streak. But Carpenzano does not believe
the Fed can ease its stance, given inflation is running at four times
the target rate.
"If you have inflation running higher than 0.5% month to month, the Fed
will have to go quite hawkish," he said.
Correctly forecasting a Fed pivot is the holy grail for financial
markets, given world stocks have shed trillions of dollars in value
since the United States and other developed economies kicked off policy
tightening.
The money market pullback may be unsurprising, given slowing U.S.
housing markets and a series of weak data that pushed Citi's Economic
Surprise Index to one of its steepest four-week declines in the past 20
years.
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A jogger runs past the Federal Reserve building in Washington, DC,
U.S., August 22, 2018. REUTERS/Chris Wattie
Also potentially signalling some room to manoeuvre, the key Personal Consumption
Expenditures (PCE) price index gained just 0.2% last month after shooting up
0.9% in March, suggesting inflation may have peaked.
Goldman Sachs now sees a 35% probability of a U.S. recession during the next two
years but expects dividends to fall in any case -- an event that has never
happened outside of a recession. Some Fed officials such as Raphael Bostic have
urged caution on policy tightening.
Laura Cooper, a senior investment strategist at Blackrock, predicts "a dovish
tilt" from the Fed by year-end, as "policymakers become more data-dependent
beyond the two 50 bps rate hikes priced in by the market over the next two
meetings."
Thomas Costerg, senior economist at Pictet Wealth, expects the Fed to pause
after two 50 bps rate hikes, noting U.S. financial conditions are already at the
tightest in two years.
"You could actually argue that 75% of the job has been done already," Costerg
said, adding that sub-2% U.S. GDP growth -- which he expects by year-end -- is
usually disinflationary.
In Britain, where recession is more likely, the Bank of England may find it
harder to back off.
A £15 billion government spending package announced this week means "the BoE
will need to hike into contractionary territory," Goldman wrote, predicting 25
bps back-to-back rate rises through February 2023, taking the terminal rate to
2.5%.
Finally, for the European Central Bank, tightening bets have ramped up, with 160
bps of rate hikes expected in the coming year, from 123 bps in early-May. ECB
boss Christine Lagarde has signalled rates, currently at -0.5%, will be at 0% or
above by September.
"The ECB will use this as an opportunity to get rid of negative interest rates
and any Fed pivot is unlikely to change that," Pictet's Costerg added.
(Reporting by Saikat Chatterjee and Sujata Rao; Editing by Kirsten Donovan)
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