Charles-Henry Monchau

Chief Investment Officer

PDF 

THE FACTS

The US Federal reserve hikes rates by 50 basis points yesterday evening, as it was widely expected. They increased key rate to 4.5%, the highest since 2007. Projected rates would end next year at 5.1% (+50bps beyond prior median of 4.6%), according to Fed median forecast, before being cut to 4.1% in 2024 - higher level than previously indicated (see FOMC dots below). Prior to decision, markets were expecting rates would reach ~4.8% in May.

Fed dots

fed dots

Source: Bloomberg

 

During the conference call, Fed Chairman highlighted the following key points: 

  •  The labor market remains extremely tight. Powell spent at least 7-8 minutes of the press conference endlessly repeating how hot the labor market is.
  • A restrictive policy stance is likely needed for some time;
  •  The fed needs to see substantially more evidence of lower inflation before shifting policy;
  •  The Fed still has some ways to go on rate hikes,
  • The stance isn’t yet restrictive enough even with today’s move;
  •  No rate cuts will take place until they are confident inflation is moving toward 2%;
  • They will have to hold restrictive rates for sustained time.

We also note some hawkish revisions to the inflation forecast with a majority of FOMC participants seeing core PCE decelerating to 3.5% at the end of 2023, versus a projection of 3.1% in September.
The Fed also released its economic projections: real GDP to grow by a mere 0.5% in 2023, and by just 1.6% in 2024. It sees the unemployment rate rising to 4.6% by the end of 2023 (vs. 3.7% now), i.e the Fed sees more economic pain ahead as this is the price to pay to fight inflation.

OPINION

So overall a hawkish message which wasn’t fully bought by investors as:

  • The dollar reversed some of its initial spike;
  • Treasury yields mostly ended the day lower in yields. The short-end notably underperformed however (2Y + 2bps, rest of curve down 1-2bps) which flattened the yield curve;
  • The market is now pricing in rates being lower than current rates by January 2024;
  • Rate markets lean toward a further slowdown in the pace of rate hikes for the first half of 2023, with likely incremental movements of 25bp. Indeed, the odds of a 50bps hike in Feb is now at just 25% while the odds of a March 25bps hike rose to 60%. There's a 76%chance that The Fed will not hike in May.

In other words, the bond market isn't buying Fed hawkishness. The Fed can change the Dot Plot all they want, but at this point in the cycle the market believes there is no chance they’ll be able to keep rates above 5% for the entire 2023.
So why the Fed message wasn't taken too hawkishly? Investors think the Fed is bluffing. And that current tightness will lead to lower inflation quicker than the Fed said.
Bottom-line: The Fed remains hawkish and the statement takes back some of Powell’s perceived dovishness at his recent speech.
The clustering of dots for 2023 above 5%, with only two below that level, shows an FOMC on the same page to get the job done (at the risk of triggering a recession).
Bulls believe that falling inflation could allow the Fed to deviate from its aggressive path before it's too late - and this should trump the negative effects of downward revisions to earnings. 
They might be right but there are many downside risks attached to this scenario. 
In the short-term, the Fed might have to keep a hawkish communication as the easing of financial conditions (due to a less hawkish interpretation by the market) is counterproductive to what the fed intends to achieve. 
In the medium-term, there are two additional issues. First, the assumption that a Fed which would turn less hawkish would help increase equity valuations doesn’t take into account the fact that equity valuations are not cheap (equity risk premium currently stands at 2.5%). Second, the fact that the Fed is still pursuing quantitative tightening and not cutting rates at a time the economy might enters recession and earnings revision are being downgraded is something which hasn’t happened in the past (see table below). The key turning point in terms of monetary policy will not be a pause but rather a clear pivot (i.e rate cut). This will only take place if something breaks (the economy or the market). This means that equity volatility could stay elevated for some time.   

 

pic 1-Dec-16-2022-07-50-43-1922-AM

 

Disclaimer

This marketing document has been issued by Bank Syz Ltd. It is not intended for distribution to, publication, provision or use by individuals or legal entities that are citizens of or reside in a state, country or jurisdiction in which applicable laws and regulations prohibit its distribution, publication, provision or use. It is not directed to any person or entity to whom it would be illegal to send such marketing material. This document is intended for informational purposes only and should not be construed as an offer, solicitation or recommendation for the subscription, purchase, sale or safekeeping of any security or financial instrument or for the engagement in any other transaction, as the provision of any investment advice or service, or as a contractual document. Nothing in this document constitutes an investment, legal, tax or accounting advice or a representation that any investment or strategy is suitable or appropriate for an investor's particular and individual circumstances, nor does it constitute a personalized investment advice for any investor. This document reflects the information, opinions and comments of Bank Syz Ltd. as of the date of its publication, which are subject to change without notice. The opinions and comments of the authors in this document reflect their current views and may not coincide with those of other Syz Group entities or third parties, which may have reached different conclusions. The market valuations, terms and calculations contained herein are estimates only. The information provided comes from sources deemed reliable, but Bank Syz Ltd. does not guarantee its completeness, accuracy, reliability and actuality. Past performance gives no indication of nor guarantees current or future results. Bank Syz Ltd. accepts no liability for any loss arising from the use of this document.

Read More

Straight from the Desk

Syz the moment

Live feeds, charts, breaking stories, all day long.

Thinking out loud

Sign up for our weekly email highlighting the most popular posts.

Follow us

Thinking out loud

Investing with intelligence

Our latest research, commentary and market outlooks