Matterhorn or Table Mountain? Central Banks Mull the Rate Hike Summit

Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.

Eurozone Market Update

In September, the ECB delivered its tenth consecutive rate hike since 2022, raising its key interest rates by 25 bps and taking the deposit facility rate to 4%. Markets interpreted this as the bank having reached the summit of its rate hikes cycle, at least for now, as supplementary ECB commentary stated that policy rates are now set at a sufficiently restrictive level. Updated ECB projections for average headline inflation showed an upward revision in 2023 (5.6%) and 2024 (3.2%), mainly to reflect higher energy prices, but revised down the 2025 number to 2.1%. We think this leaves the door open for further rate hikes if inflation reaccelerates. Last month, headline eurozone inflation dropped from 5.2% to 4.3% (see Chart of the Month), while core inflation also fell (from 5.3% to 4.5%). Quarterly GDP (0.1%) missed expectations, reflecting Europe’s stagnating economic activity. This led the ECB to revise down their growth projections to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.

Euro Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

UK Market Update

Following fourteen successive rate hikes, September saw the BoE’s Monetary Policy Committee (MPC) vote 5-4 to pause its hiking cycle, with Governor Andrew Bailey casting the deciding vote. Therefore, the bank rate remained unchanged at 5.25%. The day before the vote, UK annual inflation data came in well below market expectations, with headline inflation printing at 6.7% versus 7.0% expected, and core inflation printing at 6.2% versus 6.8% expected. This provided a clear signal to the BoE that they should indeed follow the alternative path of having a lower peak rate for a prolonged period, as opposed to a sharp move up in rates followed by a similarly swift cut. The BoE kept its forward guidance unchanged, repeating that “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.” The MPC’s updated projections highlighted further signs of loosening in the labour market. At the same time, inflation should return to the 2% target by Q2 2025, though this is far from a given.

GBP Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

US Market Update

The Federal Open Market Committee (FOMC) voted to maintain the Fed Funds target range between 5.25% to 5.50% in September. While the markets broadly expected this pause, the Fed doubled down on its mantra that interest rates will remain higher for longer, with its updated projections suggesting that the economy will enjoy the “softest of soft landings.” However, despite recent favourable inflation news, most policymakers still see one more hike in 2023 as appropriate. The FOMC’s economic projections showed a 50 bps upward revision for the interest rate in 2024 and 2025, and the equivalent of two 25 bps cuts next year. The US labour market is now approaching pre-pandemic norms, While the Institute for the Supply Management manufacturing index registered 49.0, still signalling contraction, it is up from a six-month high of 47.6 in August, suggesting a positive trend.

USD Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

Looking Ahead

The actions of the three central banks suggest that perhaps we have reached the summit of this hiking cycle or are at least on the final ascent. The debate now shifts towards what the shape of the mountain top looks like - Matterhorn or Table Mountain? Matterhorn implies a sharp move up in rates followed by a similar move down. However, the Fed, ECB and BoE have made it abundantly clear that they prefer the flat top of Table Mountain. All three have used forward guidance to deliver this message to the market. The BoE's pause should not be interpreted as a premature declaration of victory on inflation. The risk that it hikes to 5.5% is not a small one. Both the Fed and ECB will have a more balanced approach, relying on backward-looking data (notably inflation) and forward-looking growth indicators. Importantly, neither has shut the door on further rate hikes, as inflation projections remain above their 2% target in the medium term, but as things stand, there is a strong likelihood that this was the final hike of the cycle.

Chart of the Month: No Declaration of Victory Yet as Central Banks Remain Open to Future Hikes

_{Source: Bloomberg as of 30 September 2023}

_{IMPORTANT INFORMATION}

_{For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors.}

_{The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. Northern Trust Asset Management’s (NTAM) and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor. This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.}

_{All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM’s efforts to monitor and manage risk but does not imply low risk.}

_{Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2A of the Form ADV or consult an NTI representative.}

_{Forward-looking statements and assumptions are NTAM’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.}

_{Hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of NTAM.}

_{This information is intended for purposes of NTI and/or its affiliates marketing as providers of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA). NTI and/or its affiliates are not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. NTI and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing and other services rendered to various proprietary and third party investment products and firms that may be the subject of or become associated with the services described herein.}

_{Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors, Inc., 50 South Capital Advisors, LLC, , Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.}

_{NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE}

_{© 2023 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A.}