Monetary policy decisions from the Federal Reserve and Bank of England were the main events last week, with both central banks announcing further interest rate hikes. The Fed was comfortably the more hawkish of the two, delivering its first half-percentage point hike since 2000 and strongly hinting that it intends to increase by the same amount at its next two meetings.
A seeming rejection by Fed chair Jay Powell of a touted 75bp hike caused a brief reversal of prevailing market trends, but this proved short-lived, as US stock markets handed back the initial gains, the dollar continued to strengthen and bond yields resumed their march higher with the 10-year Treasury yield hitting 3% for the first time in over three years. The rate-setting committee reiterated its desire to shift monetary policy to a so-called neutral position that neither accelerates nor decelerates economic activity – though Powell admitted during the Q&A session that he was not entirely sure what this rate was.
Once the dust settled, the update was largely in keeping with expectations, and as such the resumption of previous trends following it was not unexpected. The hike was the second successive increase in the Fed Funds rate, leaving it at < 1.0%. Market pricing for the future path of interest rates has not changed significantly, with investors seeing a rise to around 3% by early next year.
While Fed officials still believe they can achieve immaculate disinflation, that is returning inflation back to target without tipping the economy into recession, the Bank of England was less optimistic. A particularly gloomy update from the BoE predicted the UK economy entering recession in the second half of the year as inflation rises above 10%. Though the Monetary Policy Committee raised rates for the fourth consecutive meeting, on this occasion by 25bp to 1.0%, the overall message was less hawkish than the Fed. This extended sterling’s slide, with the currency falling to its lowest level against the US dollar in almost two years to trade in the low 1.20s.
The potential for policy divergence has come about due to differing inflation and growth dynamics between the UK and US. The UK is more susceptible to soaring energy costs exacerbated by the war in Ukraine and already exhibiting signs of economic weakness, particularly among consumers. On the other hand, price rises in the US have been driven more by an exceptionally strong bounce back from Covid-19 and a tight labour market, and at present is showing little sign of any economic weakness.
The latest US jobs report reaffirmed the strength in the labour market with 428k jobs added in April, broadly in line with expectations. Average hourly earnings ticked down slightly, rising less than forecast, and the unemployment rate also remained at 3.6%, despite some forecasts for a further decline. Taken together this is a pleasing development and could suggest that the upwards pressure on prices may be abating. This week’s release of the latest consumer price index will be closely viewed for more evidence of a peak in inflation, with even the highest estimate (according to Bloomberg) lower than last month’s 8.5% year-on-year reading. Should inflation begin to look like topping out, the focus will likely shift towards economic growth and how much will it slow given the expected path of the Fed.
First quarter earnings season is drawing to a close and, by and large, updates have been positive. Around 80% of S&P500 companies have now reported with approximately four in five beating estimates. It’s a similar story in Europe, where roughly 60% of Eurostoxx 600 firms have reported and around three-quarter beat estimates. Although this is clearly positive, overall, it has failed to provide a major boost to equities as guidance has been fairly downbeat with future updates expected to be less rosy.
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