Executive Summary: Central Banks in Focus
The US Federal Reserve raised its base rate by 25bps to 4.5%-4.75% range, in line with market expectations. A smaller sized rate hike was no surprise for investors. However, Chairman Powell’s post-meeting speech signaled surprising dovishness, leading equities to surge. The Chairman noted that inflation has been moderating substantially in past months and is expected to cool further. Importantly, the US headline inflation now stands at 6.5% y/y after peaking at 9.1% y/y in June 2022. As a result, markets are now pricing in a Fed pivot in late 2023. Nevertheless, skepticism around this year’s market rally has grown among investors. It is widely anticipated that inflation will prove stickier beyond the 4.0% zone and, therefore, the Fed will have to engineer a strong economic downturn in order to reach the target inflation rate of 2.0%. Under this scenario, a pivot is unlikely in 2023.
US jobs reading supports skepticism for current rally in equity markets. In January, the US gained 517,000 jobs, a sharp overshoot from the expected number of 185,000. This strong payroll figure has pushed the unemployment rate to the post-Covid low of 3.4%. Moreover, average hourly earnings have also grown by slightly higher than expected rate of 4.4% y/y. Importantly, however, the pace of wage growth has moderated gradually since peaking at 5.6% in March 2022.
A surprisingly resilient and tight labor market is perhaps the greatest challenge for Fed. Further sizeable reductions in inflationary pressures are less likely, if demand for labor does not cool and wage growth does not moderate considerably.
European Central Bank and Bank of England both hike by 50 bps. BoE’s base rate has now reached 4.0% while that of ECB stands at 2.5%. Despite the hikes of similar sizes, the two central banks have diverged on their core messages. While the BoE has mimicked its American counterpart in the dovish tone, the ECB has seemingly preserved its hawkishness. This can perhaps be explained by the distinct outlooks of growth for continental Europe and the UK. While a warmer-than-expected winter forecast (among other factors) has improved the growth outlook for Europe, the UK seems to be facing a largely unavoidable recessionary scenario in 2023.
