Dr. Gil Michael Bepman, Chief Economist Dudi Reznik, Interest Rate Strategist
| Government bonds and macro
A mixed trend was recorded this week in the local government bond market. The sharp rise in yields in the US government bond market is, for the time being, only partially reflected in the domestic government bond market.
A mixed trend was recorded this week in trading in the government bond market. Short-to-medium index-linked indexes stood out in declining yields and price increases compared with stability, with a tendency for a slight rise in the long part of the indexed curve. Compared with a tendency for a slight decrease in yields in the longest part of the curve.
As a result, the unlinked shekel curve recorded a flattening compared to a significant curvature in the adjacent curve. Against the background of the rising trend in world yields, long-term bonds with a term of 10 years or more recorded price declines of close to 6% since the beginning of the year.
As a result of these trends, short-term expectations have risen to an average of about 2.90% per year, with medium-long-term expectations stabilizing around a level of 2.50% – 2.60% on average per year.
It seems that a very significant increase in inflation expectations will be required in order to bring the Bank of Israel into a situation soon, in contrast to the statements of the Bank’s heads regarding the relatively many degrees of freedom available to the Bank.
Markets in such a situation are expected to increase in the scenario in which the Fed raises interest rates “too quickly”, as the markets embody after the January publication in the US which rose by 0.6% and completed a 7.5% increase in the last 12 months.
In the coming days, the US will be published and the consumer price index will be published on 10/3/22, a few days before the next interest rate decision.
These data, combined with the development of inflation expectations in markets and surveys, which did not rise to the actual level of inflation – about 2.4-2.8% over 5-20 years – will be part of the data that the Fed will examine before deciding the policy and formulating the forward forecast it publishes to the public.
As of Friday morning, the market continues to assess the 50-point interest rate hike in a March decision (which it has not done for more than 20 years). Seems unlikely.
This seems to be an overreaction of the market, which does not give enough weight to the assessment that in terms of the effect on inflation, the results of changes in monetary policy are neither direct nor immediate and therefore the preferred approach by central banks is gradual policy moves.
Overall, the US market expects an increase of about 170 basis points in interest rates over the next year to a level of about 1.8% compared to about 0.1% today. This expectation is reflected in the bond market, where large increases in yield were recorded after the publication of the index, while the increase in yields in the shorter parts of the curve is emphasized relative to the increase in the long parts so the decline in curve steepness continues. The relatively short ranges.
| Against the background of the weakening of the shekel in January, the Bank of Israel reduced its involvement in the foreign exchange market
The Bank of Israel has only $ 356 million, the lowest purchase amount in more than a year. It seems that the weakening of the shekel during the month has helped the Bank of Israel “take a step back” from the massive intervention in the foreign exchange market over the past two years.
The Bank of Israel is gradually returning to the policy that characterized it before the Corona crisis, and after having completed its purchases of government bonds and corporate bonds, and stopped using additional expansionary monetary tools it launched at the beginning of the crisis, the Bank of Israel is trying to slow down.
The decline in involvement in the foreign exchange market began during the second half of 2021. With the exception of November 2021, the Bank of Israel’s monthly level of involvement was very low after a course of massive purchases starting at the end of 2019.
The relatively sharp declines in world stock markets during January, with an emphasis on the index and the rise in market volatility, were among the factors that helped weaken the shekel, which fell by an average of 4% against and against.
Against this background, the Bank of Israel contented itself with limited purchases after purchasing an average of $ 2.3 billion per month during the years 2020-2021. As this trend continues, it is likely that we will see the Bank of Israel reduce its involvement in the foreign exchange market, as it did in 2018-2019, when it purchased an average of about $ 3.5 billion each year.
| The growth rate of nominal wages has stabilized at around 4% and supports moderate inflationary pressures.
In November 2021, the average wage in the economy was about NIS 11,789 (original data, at current prices). This is compared to a slightly lower salary of NIS 11,673 in October last year, and a salary of NIS 11,875 in November 2021.
The average wage in the plant economy throughout the months of the year, for which data are available (January-November), at a faster rate than the average rate in the years before the outbreak of the corona crisis (2017-2019).
However, the rate of wage growth has been on a moderating trend throughout most months of the year. From a growth rate of about 6.6% in February 2021, there was a moderation to a rate of about 3.8% in July-August.
It should be noted that the rapid growth rate at the beginning of 2021, reflected the disruptions in wage data in the economy, created due to the corona crisis. The decline in the volume of economic activity at the outbreak of the crisis led to a significant wave of “Corona unemployed” (mainly workers expelled from the labor force and workers fired from the labor force), who were employed on the eve of the crisis. Upwards of salary data.
This, with an emphasis on the industries that were largely affected by the crisis (such as: hospitality and food services, art, entertainment and leisure and more). However, with the opening of the economy to activity, the demand for workers rose in most industries, and a growing proportion of the unemployed returned to the labor force, which supported the decline in wages back to a level that reflected normal activity. In addition, the payment of unemployment benefits to workers in the IDF was abolished at the beginning of the second half of 2021, and also supported the return of additional workers to the labor market.
In recent months, the average (nominal) wage in the economy has been growing at an annual rate of about 4%. This is a fast pace compared to the pre-crisis situation, as well as in relation to the growth rate of productivity (TASE 🙂 labor (the eve of the crisis). But the fact that the rate of wage growth in the economy has stabilized and has not continued to grow, may support relatively moderate inflationary pressures (it should be remembered that the unemployment rate is still high, by broad definition).
Looking ahead, as wages in the economy continue to grow at a faster rate than the long-term average for an extended period of time, this may further contribute to rising inflation. In addition, we note that the industries in which the rate of wage increase is particularly prominent are: information and communication, real estate activities, construction, professional services and also industry. in the field.
These trends are expected to continue in the coming months, in parallel with the process of recovery of the labor market from the consequences of the corona crisis, assuming a scenario that is not characterized by a significant worsening of morbidity.
| The survey of trends in business indicates a continued expansion of activity, a weakening of expectations for the coming months
According to the CBS Business Trends Survey, the industry’s net scales (the weighted difference between the percentage of company executives who reported an improvement in the situation and the percentage of company executives who reported a deterioration) are relatively stable and indicate that economic activity continues to expand at a similar rate. , With moderate industry variability, with manufacturing and services industries indicating faster expansion compared to other industries.
We will also note that with the exception of the construction industry, the net balance sheets of the other industries are in an environment similar to the level at which the Corona crisis broke out on the eve.
An examination of additional indices indicates a continued recovery of economic activity, but while expecting a certain slowdown in the pace. The data for the last two months (December 2021-January 2022), in particular: the expectations for activity in the next three months and the expectation of an increase in the volume of employment, indicate a moderation in the rate of expansion. This, apparently, against the background of the increase in morbidity due to the outbreak of the “Omicron” strain and the increase in the degree of uncertainty.
As the wave of morbidity continues in the declining trend, in parallel with the continued expansion of activity and the continued improvement in the labor market, an improvement is expected in the coming months in the business sector’s assessments of activity in the future.
The survey of trends in business indicates a continued expansion of economic activity, while expectations of economic activity in the coming months have moderated, apparently, under the influence of the increase in morbidity in Corona. This is in line with our assessment, as well as the assessment of other entities, such as the Bank of Israel and the International Monetary Fund (IMF), that most of the negative impact of the “Omicron” wave is expected to be concentrated in the first quarter of the year.
In this context, we note that the expenditure data on credit cards published by the Bank of Israel indicate only a moderate effect of the increase in morbidity on activity so far. The data indicate a decrease in purchases of credit cards, especially in the field of tourism, and a more moderate weakening in purchases in the field of education and leisure. In the other industries, the rate of acquisitions remained similar to that of previous months. Looking ahead, we anticipate a rate of 4.6% on domestic GDP in 2022, in a key scenario.
| Global Macro: The US Inflation Environment at a Peak of 40 Years
There is an expectation in the markets for a sharp and rapid rise in interest rates in the coming months. It is not inconceivable that the steepness of the 2-10 curve in the US will decrease further until the policy expectations are clarified through a clear FORAWRD GUIDANCE in the March decision.
The US consumer price index surprised considerably upwards and rose by 0.6% in January compared to the consensus’ average expectation of an increase of 0.4%. Over the past 12 months, the overall index has risen by 7.5%, well above expectations of an increase of 7.3 %.
This is the largest annual rate of increase since February 1982.
The food, electricity and housing items contributed mainly to the rise in the index. The food index rose 0.9% in January after rising 0.5% in December. The energy component of the index rose by 0.9%. The core index, for all items excluding food and energy, rose 0.6% in January, as did the rate of increase in December.
This was the seventh time in the last 10 months that the core index has risen more than 0.5% in monthly terms. The core index has risen by 6.0% in the last year and this is the biggest change since August 1982. The energy index has risen by 27.0% in the last year and the food index has risen by 7.0%.
Regarding the expected policy measures, in the days before the publication of the index, the President of the Federal Reserve of Cleveland, Loretta Mester, presented the following roadmap: The Fed will reduce the volume of its balance sheet assets mainly by adjusting the investment amounts ) In respect of the assets held in its balance sheet in a “passive” manner.
It supports the sale of some of the MBS (mortgage-backed bonds) in the Fed’s balance sheet in order to accelerate the change in the composition of the Fed’s assets in order to achieve a greater weight of government bonds, this is an MBS that the Fed is gradually seeking to remove from the balance sheet.
According to her, said before the index was published, as long as the economy does not surprise, it supports the beginning of the interest rate hike in March at a relatively fast pace because inflation is high and labor markets are much tighter than in 2015 (the period before the previous interest rate hike of 0.24 % At the end of 2015 to 2.4% at the end of 2018).
Prior to the publication of the index, it stated that it does not support the first step of raising the interest rate by 50 basis points, but now it seems that this assessment is in question and immediately after the publication of the index the likelihood of a first 50 bn increase has risen sharply.
Its estimate was based on the expectation of a decline in inflation later in the year, when demand moderates and when supply-side constraints fall further, as has recently begun to show in US foreign trade data, but now such a development in curbing inflation seems to be receding. Of Atlanta, Rafael Bustik stressed, before the index was published, that despite the high degree of uncertainty, it still prefers 25-point interest rate hikes, but it now appears that this statement should be reconsidered in light of the continued acceleration in inflation. Yes and the annual rate is expected to rise further in the next index.
The main concern about a move of too fast tightening or too large steps of raising interest rates by the Fed is in causing the yield curve to flip (as indeed happens in practice and quickly after the index is published), while yields to maturity in the short part of the curves rise rapidly in response to the Fed’s big and fast move. When long-term yields do not work this way, it is because they are anchored in the underlying factors that do not support such a rapid rise in yields.
A reversal of the curve, and in particular the level of yields to maturity higher in the two-year maturity range than those of 10-year maturity may send markets a strong message of apprehension of an impending recession and this may be a negative signal to stock markets and consumer and business confidence more generally.
| The monetary tightening in the world continued with the continued rise in interest rates in Poland
The Central Bank of Poland (NBP) increased by a further 50 basis points, to 2.75%, and it appears that the background conditions of wage and price pressures will lead to further increases to 4.50% in the current tightening cycle. The highest rate in more than two decades, which was affected by a sharp rise in energy prices and a higher core, which reached 5.3%.
Meanwhile, the annual rate of increase in nominal wages accelerated to a decade-high of 11.2% against the background of a tight labor market, with unemployment falling to a low of 2.9%, well below its natural rate (4.5-5.0%).
These developments have become a factor that signals the danger of a wage-price spiral and therefore the continuation of the steps of the central bank. The governor noted last month that interest rates should rise more than what markets are currently pricing. Also, recently the Governor noted that the addition of the zloty is consistent with the direction of monetary policy.
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The writer is the chief economist of Bank Leumi. The data, information, opinions and forecasts in the review are provided as a service to readers, and do not necessarily reflect the official position of the Bank. They should not be construed as a recommendation or substitute for the reader’s independent discretion, or an offer or invitation to receive offers, or advice for the purchase and / or execution of any investments and / or actions or transactions. Errors may occur in the information and changes may occur. The Bank and / or its subsidiaries and / or companies related to it and / or the controlling shareholders and / or stakeholders in which of them may from time to time have an interest in the information presented in the review, including financial assets presented in it.