Carmignac: Central Banks meetings preview

13 juni 2023

The Fed has achieved what it set out to do. It’s brought policy rates to where it said it would and managed to erase expectations of a rate cut for the rest of this year^[1]. But for policymakers, this does not equal “job done”. We anticipate the Fed will put its rate hike cycle on hold at June’s meeting.

Torn between the strength of recent economic data and the long and variable lags between monetary actions and the effect of monetary policy, we expect the Fed to adopt a wait-and-see approach.

With persistent inflation, mixed economic releases and a job market that remains tight many are anticipating a further rate hike at July’s meeting. It is a real possibility. But Jerome Powell needs to buy himself some time. The stress on US regional banks has subsided, so the macroeconomy is back in the driving seat of monetary policy.

It’s in the Fed's interest to wait and see whether services will follow the slowdown in manufacturing, whether the recent rebound in the property sector is confirmed and, above all, whether the labour market eventually shows signs of fatigue.

Nevertheless, the tone adopted on Wednesday should be hawkish, to rule out any interpretation that the task is complete when underlying inflation has still not fallen below 5%.

The European Central Bank (ECB): Encore

Although the European monetary tightening cycle began four months after the Fed’s, without any major mishaps, it is making itself felt.

Leading indicators (manufacturing PMIs, in particular) and the slowdown in demand for credit from households and businesses (last month's net demand for credit fell to 0) show the tightening is working. As does the broadening of the disinflation trend – the latest consumer price index figures must have been a real relief in Frankfurt.

And yet, the ECB is expected to hike deposit rates by a further 25 basis points on Thursday. The rate of disinflation has surprised on the downside, but the level of inflation remains high (6.3% in Germany and 5.1% in France for total inflation year-on-year).

These levels call for sustained vigilance. 5% is a particularly important threshold, associated with more homogeneity in price rises across goods and services and a greater link with wages^[2]. The rigidity of the European labour market is also leading to greater inertia on the wage front, which is growing at a rate of 5% year-on-year. And so, the potential is that real wages (adjusted for inflation) will move closer to positive territories and thus support consumption. This could in turn boost core inflation.

July’s meeting is also likely to see the European monetary institution raise its deposit rates by 25 basis points, possibly for the last time if the disinflationary trend is confirmed. In that respect, Christine Lagarde has managed (so far) to complete her monetary tightening cycle without the materialization of cracks in the system, even though one year ago the region was said to be the least ready to face a tightening cycle.

Consequences for the markets

The pace at which policy rates are rising is slowing, or coming to a halt, but this does not mean that the hiking cycle has de facto come to an end. Central banks are dependent on economic data, so we must prepare for a variety of scenarios.

Against this backdrop, we prefer core bonds with long to intermediate maturities (between 5 and 10 years). Shorter maturities are too dependent on volatile economic data (employment, wages, leading indicators). Confirmation of the economic slowdown and the pace of disinflation will push interest rates to much lower levels across the board.

Conversely, if the economy shows even greater signs of resilience, this would lead central bankers to raise policy rates further, which in turn would weigh on the longest-term bond yields given more pronounced tightening of monetary policy increases the likelihood of the economy contracting sharply.

^{[1] Not long ago markets saw policy rates at 4% in December, i.e. 1% lower, or the equivalent of four 25 basis points rate cuts. Which in fact is much more effective than having to raise its key rates for the eleventh consecutive time.}

^{[2] https://www.bis.org/publ/bppdf/bispap133.pdf}