The intensity of the events in the markets in the last three trading days was in stark contrast to the feeling of the “weekend that lasts forever” in Israel. The Fed’s interest rate announcement has caused markets to make one of the most impressive plaques in history and raise many question marks about the way forward. Since you have already received an analysis of the announcement on Thursday morning, we will now try to focus on the main reasons for the sharp and rapid change of direction recorded between Wednesday and Thursday and the expected interest rate path for the coming year.
The immediate reaction to the Fed’s rate hike was, as I recall, a sigh of relief from investors and sharp price rises. On the face of it, the main reason for this seemed to be that Powell had lowered from the table the possibility of raising interest rates by 75 basis points in the coming months and thus for a while reduced the pressure on the markets. Promised to keep.Do not have to go far in the pages of history to see that the Fed forecasts are not often fulfilled and that market expectations are a better indicator of forecasting than the statements of Powell and his friends.Even after Powell’s announcement, futures still price a 24% probability of raising 75 PS In June, the probability is likely to rise if inflation expectations rise. By the way, there is nothing in it that detracts from the ability and skills of the Fed members since their function function is not to predict what will be but to try and influence the expectations of the investors to force the market their will. Because the Fed is trying to fight inflation and especially inflation expectations it needs to retain the ability to surprise the markets. If markets expect interest rates to rise by 75 basis points then to surprise them the Fed will have to raise interest rates more sharply. However, if Powell says interest rates will not rise by 75 basis points, it will be easier for him to surprise if he has to do so. . For someone whose psychological mambo jumbo on expectations and future guidance is not his cup of tea * We will mention two more factors that were significant to our assessment in the internalization of the markets that the Fed announcement is not good news.
First, the Bank of England announcement on Thursday was a kind of trailer for future Fed announcements and contained virtually everything the market fears. Although the BOE raised the interest rate by only 25 basis points, according to the announcement, the English Monetary Committee was not formed when two members wanted to raise it by 50 basis points and two others generally thought there was no point in signaling further increases in the future. Moreover, the Bank of England also for the first time clearly put the recession on the table and estimates that growth in 2023 will be negative. The Fed’s forecasts will also be updated downwards and will probably show that interest rate hikes have a painful price in the economy.
Second, the Fed’s decision to raise interest rates more slowly (again, ostensibly) is not necessarily good news for markets since sometimes slower is also too slow. As Sagi noted with great accuracy as early as Thursday morning, long-term inflation expectations (5Y5Y) rose after the Fed announced. This increase indicates that the markets fear that raising interest rates too slowly will not be able to stop inflation in time and interest rates will simply be high for a longer period of time. In other words, it is quite possible that sharp interest rate hikes and the emptying of the market from the hot air are preferable to moderate interest rate hikes and staying in a situation where there are worthy solid alternatives over time. The changes in the crooked structure show that this is indeed a legitimate concern in the eyes of the markets. According to work our friends at JPMorgan released last week, 93% of the changes in the steepness of the curve in the past six months have been driven by the two-year yield. This is of course a very logical conclusion since the question that investors have been asking themselves most of the time has been how fast the interest rate will go up and not what it will be in the long run. In contrast, in the days following the Fed announcement, the rise in yields was driven by the long and crooked yields becoming steeper. Such a change indicates that the market is actually losing confidence and estimates that interest rates will reach a higher level in the medium term because the Fed will have a hard time stopping inflation.
Bottom line, the Fed allegedly gave the markets a gift on Wednesday when it announced that interest rate hikes would be “50” only “but with such gifts the phrase” hates gifts will live “gets sub-validated. I have cigarettes from the duty free and when she refused because “cigarettes are not a gift” I asked instead for a good whiskey that only made me smoke more.
* Academic research on monetary policy in recent years shows that the most powerful tool of a central bank is to direct investor expectations so that it may be a mambo jumbo but it is the same mambo jumbo that Fed members are familiar with.
Employment report and the future of inflation
You also received the full details of the April employment report in a fast delivery already on Friday, so we will only dwell here on the trends in wage pressures in the United States. Hourly wages rose 0.3% in April, a rise that was more moderate than expected. Not only that, but in fact for several months now there has been a slowdown in the rate of wage increases in the US. In fact, if we look at the change in wages in the last three months then it seems to be an increase of 3.7% (in annual terms) In other words, even if the current situation in the labor market is maintained, then as time passes the annual rate of increase in wages will decrease. This is not a trend that should come as a surprise since government pensions ended a few months ago Looking for work and the pressure on wages is eroding.The decline in the participation rate recorded in April also comes mainly from the age group 24-16, ie not from the ages of 64-25 who usually constitute the main labor force so it can be assumed that this is an event that does not teach the rule. Naturally, a drop in wage pressures will at some point also translate into a drop in inflationary pressures (4-2 quarters behind) that comes from demand so this is good news for the Fed that could probably take its foot off the brake pedal sometime during 2023. Signs of a reduction in inflationary pressures. We have re-written here and in every presentation we have had in recent months that the corona clauses have contributed a large part of the inflation we see being in the US and the rest of the world. In fact, it is enough that car prices, transportation and energy Will stop rising So that inflation will decrease by about 4% !! Meanwhile, the Manheim second-hand car price index recorded a third consecutive decline in April, signaling that inflation could be eroded by more than 4% through the supply side. Moreover, we estimate that the rate of decline in vehicle prices will increase as the cost of credit rises and the shortage of chips and vehicles is resolved, which may return inflation to favorable areas for the Fed, certainly if the demand side also sees a moderation and a slowdown in the economy. Therefore, we reiterate the argument that the Fed’s interest rate hikes will stop earlier than the market currently estimates and that in the medium term the negative trend in the markets will be reversed.