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A Tale of Two Halves 

Stocks have fallen hard the last couple of sessions really on an accumulation of central bank hawkishness and the dawning realisation that 2023 could see a real earnings recession, which wiped out some of the early week optimism around signs of softening inflation. Similarly, after a decent run-up Mon-Wed, crude prices have pulled back with spot Brent at $80 this morning.  

With central banks seemingly loathe to signal any sort of pivot, even if they are slowing down the rate of hikes, risk took a big hit with stocks down 2-3% for the session yesterday. NDX fell over 3% to 10,820 area, the S&P 500 down 2.5% to below 3,900. The FTSE 100 was a little insulated due to weaker sterling and defensive qualities, down almost 1% at a little over 7,420. The DAX, touching the round number 14,000 support, and CAC, hitting 6,500, both dropped around 3% to the weakest in over a month.  European stocks are a lower again in early trading on Friday, looking to notch weekly losses of 1-3%. Looking at the major indices you can see they’ve almost completely retraced the whopping early November rally that came about from softer inflation signals.  

So, we’ve had the three big central bank moves – all went for 50bps hikes, each set out a new mode for 2023. The Fed stressed that rates would be higher for longer – exactly in line with what I’ve been saying and noted in our Watchlist report. The BoE didn’t say the market was pricing in too many hikes, though I still think the Old Lady has a lot less appetite for really hiking hard, except for indefatigable Catherine Mann. Christine Lagarde was about as hawkish as she’s ever been. There has been a shift this week and we need to drill into what this means. Firstly, it is clear that the economic backdrop and outlook for each of the UK, EU and US are similar in many ways, with inflation hot but falling ever so slightly (mild disinflation) and growth heading south into possible recession. The US though is in a better place than the other two - there are important differences, as well as very different reaction functions of their respective central banks. What seems clear is that, in their own different ways, they are starting to see the stagflation, but they don’t get that this will last. First inflation was transitory, now they claim stagflation will be too. This seems an error. My personal view is that the Fed stays at it longer than peers and the dollar can’t stay weak for long . The market’s pricing for the ECB’s terminal rate rose after the statement but it’s still not buying what Ms Lagarde was peddling.   

  

Bank of England  

The Bank of England hiked rates by 50bps as expected to 3.5%. But a 6-3 vote split pointed to lingering doubts about the path of monetary policy. Swati Dhingra and Silvana Tenreyro preferred to leave rates unchanged whilst Catherine Mann preferred another 75bps hike. Mann said it’s important to push back against the inflation psychology...the two doves said 3% is enough to bring +10% inflation down...go figure. Anyway, nine straight hikes and more to come it seems.  

Most MPC members agreed a need for more rate hikes, and the statement did not repeat the November line about rates unlikely to reach the peak implied by the market. But it’s not clear if there really is a further 100bps in this committee. Two ultra-doves don’t hold much sway right now but as the economic situation deteriorates others may lean towards their camp. The Bank thinks CPI inflation has peaked but it will remain ‘very high’ in the coming months.   

Market reaction saw gilt yields fall and sterling drop hard, pushing a little lower still this morning. Market bets for the peak in interest rates in August 2023 fell a touch to 4.5% from 4.6%. 5yr interest rate swap spreads declined sharply to the narrowest since early May.   

  

ECB  

Hawks in charge: The ECB statement was quite hawkish; Lagarde was even more hawkish saying the ECB would need to hike at 50bps for a period of time and needs to do more than the markets price...implies the c3% terminal rate priced by markets is way out of step...or markets are indeed right to doubt the ECB actually pushing this hard.  

Italian yields leapt, traders priced in a higher terminal rate and European stock markets plunged 3%. The euro rallied initially before falling back sharply, this morning EURUSD trades around 1.0650.   

There was a noticeable upping the ante in the opening paragraph of the statement. The ECB said interest rates would “still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target”. This was a step-change from the “substantial progress” hailed in the October statement. Lagarde went further in the press conference, effectively outlining at least another 100bps of hikes by March. JPM have raised their terminal rate projection by 75bps to 3.25%. 

In terms of growth, it was still quite bleak but pointing to shallow-ish recession with a decent pick up in 2024/25. Probably a bit optimistic. Staff inflation projections were revised up a lot but still see big disinflation trend in 2023 which seems like it’s far too optimistic. Lagarde noted that wage growth is strengthening, also fiscal measures could worsen inflationary pressures.   

We got some extra clarity on reducing bond holdings with the ECB saying that it will, from March, not reinvest all of the principal payments from maturing securities from the APP portfolio. The decline will amount to €15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time.  

  

Fed  

The main message I got from the Fed and Jay Powell this week was that they are not even thinking about thinking about when to cut rates. A higher terminal rate should be expected. Richard Clarida, former vice chair of the Fed, noted in a blog that markets have been too keen to price in cuts next year. He points out that “if financial conditions ease because markets price in [2023] cuts, a peak policy rate of 5.25% may not be sufficient to put inflation on a path to return to 2% over time”. Higher for longer.  

  

Growth worries  

Chinese data for retail sales and industrial production was poor. US retail sales fell to the lowest level in almost a year, dipping 0.6%. Consumers are still wearing higher prices, but we are seeing cracks now. US initial jobless claims were down 20k, while continuing claims were up again to 1.67m. Today, various flash PMI estimates point to a sluggishness in economies. On the US, Pantheon says “we are on alert for a sharp slowdown in the first quarter, as a softer labor market makes people less willing to run down savings accumulated during Covid to maintain elevated consumption.” 

  

SPX   

Bearish MACD crossover proved worthy again, now looking to see if the 50-day SMA holds. Breach here may see 3,700 retested, however seasonality is a major factor and look for a possible end of year relief rally. Triple witching today with roughly $4tn in options set to expire provides catalyst for breakout from 100-points either side of 4,000 range the index has traded the last few weeks.  

  

 

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