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Pointing to a pivot?

Weekly update
  • Weekly market update
  • 5 minute read

A good week for

  • Equities broadly rose in sterling terms, led higher by the Japanese and US markets, which rose between +2.5-3%
  • UK and US bonds crept higher in local currency terms

A bad week for

  • Sterling weakened against both the US dollar and the euro
  • Oil fell c. -1% in US dollar terms

Federal reserve

Markets remain focussed on central bank activity, with US, UK and European central banks all meeting this week. The US Federal Reserve (Fed) slowed the pace of monetary tightening at its December meeting, raising rates by 0.5% instead of 0.75%. Futures markets suggest that investors now expect the Fed’s Open Markets Committee (FOMC) to slow the pace of tightening further still, from a 0.5% rise to a 0.25% rise. Looking further ahead, futures markets anticipate rates peaking around 5% in the summer, before the Fed begin cutting interest rates once again, with a 4.5% level anticipated by the end of the year. While FOMC comments do suggest that there is appetite to slow the pace of tightening, their forecasts suggest members see rates staying higher for longer.

US economy

One factor that could influence the FOMC’s monetary policy decision is December’s GDP print. In Q4, the US economy grew by 2.9% quarter-on-quarter annualised. This was slower than 3.2% growth rate delivered in the third quarter, but ahead of economists’ expectations of 2.6%. The strength was broad based, with inventory investment, consumption spending, government spending, and business investment all stronger than expected. In contrast, residential investment was weaker than expected, reflecting a slow-down in this interest rate sensitive sector. Pending home sales fell 34% in the year to December, though month-on-month sales did rise 2.5%, which could signal stabilisation. Personal income data also pointed to caution, with income growth growing by 0.2% in December, in nominal terms. Factoring in inflation this means households are experiencing a real-term cut. Household spending fell by -0.2% in December, primarily due to weaker spending on goods. This translated to an increase in the savings rate, with households saving 3.4% of their income. An elevated savings rate is typical in times of weaker consumer confidence.

Bank of England

The Bank of England is also expected to raise rates this week. The policy decision will also be accompanied by new economic forecasts. The Bank’s last set of forecasts, in November, painted a gloomy picture of economic growth, anticipating negative growth in 2023 and 2024. This was expected to weigh heavily on inflation, with headline inflation expected to fall below the 2% target in 2024. Reflecting these forecasts, the policy announcement took a more dovish tone. Since November, the government have announced a more generous package to support households with energy bills, and energy prices have also fallen. In addition, GDP growth in the fourth quarter of 2022 was likely stronger than economists expected, given November’s growth print. All in all, this makes it likely that Bank forecasts of GDP growth will be upgraded. The impact on inflation forecasts is less clear – lower energy prices, as a result of lower wholesale prices and government support, will bring down inflation, while the stronger outlook for GDP growth could contribute to stronger inflation.

European Central Bank

Unlike the Bank of England and the Fed, the European Central Bank (ECB) has been sending a hawkish message in recent months, and is expected to hike by 0.75% this week. Mild weather in Europe has allowed energy prices to fall, bringing down European inflation faster than expected. This has also made it likely that European energy reserves will be higher than anticipated at the end of the winter, and has reduced the likelihood of energy shortages in 2023 and 2024. As a result, GDP forecasts for the Eurozone are likely to be upgraded. Futures markets are currently expecting the ECB to continue hiking into the late summer, with interest rates hovering around 3.5% into 2024.

Business Surveys

Business surveys can provide a useful barometer of the health of the economy. In January, Purchasing Managers’ Index (PMI) data mostly remained below the “50” level which signals expansion. Readings under 50 suggest that conditions are deteriorating and often coincide with periods of economic contraction. However, elements of the business surveys did indicate improvement in the US, UK and Europe, as well as Japan. In aggregate, the developed market all-industry PMI recovered to 48.3 in January, reflecting the expectation that 2023 will be a year of weaker growth, albeit forecasts are improving.

 

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