A tense couple of weeks lie ahead for global financial markets.
Investors have spent the past few days resigning themselves to the fact that U.S. and euro zone interest rates are going to rise more than seemed likely at the start of the year. Hopes for a quick end to monetary tightening and an imminent “turn” toward interest rate cuts by the end of the year now appear to be fading.
Short-term interest rate futures now reflect expectations that federal funds rates will peak at 5.5% and ECB refinancing rates at 4%. That’s 0.75% and 1%, respectively, higher than right now. As for rate cuts, they won’t be seen before 2024.
The world’s top two central banks are tightening financial conditions further, so headwinds for global markets, which have thrived since 2009 thanks to historically cheap money, are likely to intensify, at least in the short term.
However, there is reason to think that neither the meeting of the ECB in Frankfurt next Thursday, nor that of the Federal Reserve A week later, they will be as aggressive as feared.
First, Fed Chairman Jerome Powell left himself plenty of wiggle room on Tuesday, when he told the Senate Banking Committee that the Fed could aimlessly reverse higher rate hikes “if the totality of the data indicates that an acceleration of tightening is warranted.”
The loss of credibility this would entail, just a couple of months after saying that a disinflationary trend had been established, means that the most likely outcome when the Fed meets is still a 25 basis point hike.
Secondly, the ECB will not like having to be first. It will almost certainly raise its policy interest rates by 50 basis points, but the key variable — Lagarde’s guidance for the next meeting in May — will be tempered by the certainty that it rarely pays to appear more hawkish than the Federal Reserve.
At $1.06, the euro remains cheap against the dollar, and eurozone companies have a clear financing advantage over their US counterparts (a much-needed advantage, given that energy and non-wage costs are much higher in Europe than in the US).
That’s why Lagarde is unlikely to immediately commit to another 50 basis point hike in May.
After all, why would he? The Inflation is going down (although the rate basic accelerated in February), and leading indicators suggest it will fall even faster and faster starting in the second quarter, as this year’s prices begin to compare with the rebound a year ago. The Producer price inflation The inflation rate, in particular, is slowing sharply, to “only” 15% in February, up from peaks of more than 43% in September.
As Holger Schmieding, chief economist at Berenberg Bank, states, natural gas prices “remain the most important driver of euro zone inflation,” and on Thursday they reached their lowest level since the summer of 2021, after a large Gulf of Mexico LNG export terminal got the go-ahead to resume operations.
For their part, the Dutch TTF futures, benchmark prices for northwestern Europe, which looked set to settle in a range four or five times higher than their historical average following the loss of cheap Russian gas, are now trading at only twice that figure. While this remains damaging, particularly for such an energy-intensive industry, it is less likely to make the difference between life and death for other Eurozone companies.
But, while inflation is undoubtedly falling, there remains great uncertainty about how far and how fast it will fall. Food prices, in particular, remain a concern, given the lagged effects on harvests of the disruption of global fertilizer trade.
Konstantinos Venetis, from TS Lombard, in a preview of the meeting of the Bank of England A day after the Fed’s, inflation never falls in a straight line, something that is likely to frustrate both the more aggressive and the more prudent in the Monetary Policy Committee. Their counterparts in Washington and Frankfurt are likely to feel the same way.
In the minds of the three central banks in the next 15 days will be the first signs of stress in the American banking system. The collapse of Silvergate, a banking-focused institution for the cryptocurrency sector, can be considered a graphic example of that isolated niche of financial markets. But the problems of Silicon Valley Bank, which has suffered billions of unrealized losses in startup loans, are something else entirely. After all, much of the American financial system, wholesale and retail, has bet heavily on startups in one form or another over the past decade.
Before the last financial crisis in 2008, central banks continued to raise rates long after systemic problems began to become apparent, making the subsequent crash worse than it might otherwise have been. Given the tendency of the authorities to fight in the previous war rather than the one in front of them, the risk is that this generation of central bankers will lean in the opposite direction.
“We are approaching the point where the macroeconomic costs of taking ‘too aggressive measures too long’ in terms of rate hikes start to outweigh profits,” warns Venetis. “As the tightening cycle enters an advanced phase, this warrants a more nuanced approach to monetary policy.”