Carmignac: Expectations for the FED, ECB and BOE meetings this week and beyond

December 13, 2022

By Kevin Thozet, Member of the Investment Committee at Carmignac

December 2021 saw the three main central banks of the developed world turning hawkish. A stance they kept for most of this year. So, as we approach the final monetary policy meetings of the year, the question for investors is “will central bankers choose to show their might one more time?”

The last months have seen soft data (e.g. consumer sentiment, purchasing managers’ surveys) continuing to move lower but hard data (e.g. unemployment, retail sales) have held relatively well. As a consequence, this week we should see interest rates being hiked on both sides of the Channel and the Atlantic but with some form of measure in the pace of hikes going forward.

Such a “middle way” affords central bankers a treasured longer time period to assess the “damage” 12 months of stricter tones and higher rates have had on the economy.

But sharing a common big picture is not antinomic with the different realities each central bank faces and we are more likely to see policy divergence in 2023.

THE FEDERAL RESERVE

This week a 50 basis points rate hike is expected. And given the Fed’s well publicized path to a terminal rate of 5%, we’re unlikely to see any major surprises for the first meetings of 2023 especially with Mr. Powell moving away from prioritizing spot inflation to a focus on the longer 2% inflation objective.  As such, for now, monetary policy has been somewhat reduced for the first part of 2023: it took seven months to move from 0.5% to 4%; it will take three months to bring them to 5%.

Beyond this is where things get interesting. If and when the Fed will pivot is the key question on investors’ minds, especially in light of Powell’s increasingly dovish tone. We see three potential scenarios:

1) The materialization of a hard landing for the US economy leading to a rapid turn towards easing.

2) A soft landing would see interest cuts later than many anticipate.

3) Sticky inflation meaning rates stay at terminal level for longer before moving even further into restrictive territory.

THE EUROPEAN CENTRAL BANK

Although late(r) to the rate-hike party than its peers, the ECB has acted aggressively in recent months in the face of inflation. This week, the tightening story continues. We anticipate a 50 basis point increase but a 75 basis points hike shouldn’t be discarded.

The risk of a more hawkish monetary policy is tilted to the upside as the ECB has indicated its uneasiness on the future inflation path, deeming that the recession won’t be enough to tame soaring prices. And since PMIs fell to 47 (50 being deemed recessionary levels, leading the actual contraction by 6 to 9 months), several fiscal support measures have been announced and hence the recession should be even shallower than initially expected. As such, the path towards disinflation should be pushed further out and require an even tighter monetary policy.

THE BANK OF ENGLAND

The specter of stagflation looms large over the United Kingdom.

With economic activity slowing and the country being among those where inflation expectations are least anchored, Monetary Policy Committee members are facing quite a conundrum. Most members have been voting in sync over the past year with inflation being the (unifying) primary enemy but the delicate growth vs inflation quandary could see a three way split going forward.

The dire prospects for the UK highlight the “need” for a more aggressive monetary stance by the BoE given the distance remaining from the current interest rate level of 3% towards the expected 4.5% - which already appears quite optimistic.

This week we expect a 50 basis point hike but given the likelihood of growing disagreement, the risk of flip-flopping is becoming ever more real.

MARKET AND PORTFOLIO IMPLICATIONS

2022 has been a year of extreme volatility as central banks quickly move through their rate hiking cycles. The good news is that as the Fed’s terminal rate is not expected to move significantly, and as US interest rates become more anchored, other asset prices should return to more normal patterns of behaviour.

In such a context, spread assets and most notably credit markets are expected to be relatively well behaved over the coming weeks. This means they can provide a very attractive performance engine in both absolute and relative terms, in fixed income and diversified portfolio alike.

Integrating the upside risk to interest rates in the Euro Area, keeping long positions ahead of the 15 December meeting doesn’t seem appropriate; and yet, given the gloomy economic outlook, nor does implementing short positions on EUR rates. Therefore, limiting directional positions in EUR core rates is warranted.

We see the main risks as most apparent on US 5 year maturities. In our view, market participants’ expectations that the FOMC's target federal funds rate will reduce by 2% by 2025 is overly hopeful.