- Daniel Farrell
- Director, International Short Duration Fixed Income, Northern Trust Asset Management
Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.
Eurozone Market Update
Headline annual inflation in the euro area dropped to 9.2% in December, the first time it has been in single digits since August. Core inflation remained sticky, however, rising to 5.2%, and above market expectations of 5.0%. This raises a concern as the ECB focuses on core inflation numbers when deciding about upcoming hikes. On the targeted longer-term refinancing operations early repayment programme, January’s repayment of €62.6 billion — close to the market expectations of €65 billion — failed to swing the market. According to the ECB’s minutes, the near-term economic outlook is slowly improving, helped by mild weather in December, reduced gas prices, China reopening and government support. The risk of a deep recession has waned (for now).
UK Market Update
In the UK, annual headline inflation of 10.5% in December was down slightly from 10.7% in November. However, core inflation remained elevated, up 6.3%. Housing data continues to trend downwards, with house prices on track to drop 8.0% this year, according to the Halifax House Price Index. The UK’s labour market report showed average earnings (excluding bonuses) some 6.4% higher in the three months to November than a year earlier. This puts pressure on the BoE for a 50 bps hike in February, as inflation will become harder to tame if pay growth continues at this pace (see Chart of the Month). Meanwhile, the BoE has completely unwound the £19.3 billion in emergency government bonds bought in November to stabilise markets following the infamous ‘mini budget’.
US Market Update
Annual US headline inflation fell to 6.5% in December, with the core component down to 5.7%. While inflation is slowing more quickly than in 2022, additional tightening is required to reach the FOMC target rate. However, a downshift from 50 bps to 25 bps at the FOMC’s February meeting is warranted and supported by futures pricing. GDP grew by an annualised 2.9% in the fourth quarter of 2022, reducing recession fears for many market participants. On 19 January, the US hit its $31.4 trillion borrowing limit and invoked extraordinary measures to fund the government. The onus is now on Congress to act before the ‘X Date’ — the point at which the Treasury exhausts extraordinary measures — or risk an unprecedented government default. We expect elevated financial market volatility until this is resolved.
Looking Ahead
While the market is relatively sure about the policy outcomes from February’s monetary policy meetings — a 25 bps hike from the FOMC and 50 bps apiece from the BoE and ECB — particular attention will be paid to any statements that might indicate a further reduction in the pace of monetary policy tightening and the eventual peak in policy rates. Central bankers and the markets are currently at loggerheads about the future path of monetary policy. Market participants extrapolate that falling headline inflation and a recession will be enough to drag core inflation down to central banks’ inflation targets, allowing rate cuts in 2023. Central bankers have explicitly pushed back against this notion. As highlighted in our previous commentaries, we believe central bankers are far more likely to pause than to cut interest rates during the second half of 2023.
Chart of the Month: Falling Interest Rate Expectations to Play Vital Factor in Central Bank Rate Decisions
Source: Bloomberg. As of 31/01/2023
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