Is it too early for a pause in US rate hikes?
Investors were watching the meetings of the US Federal Reserve (Fed) and the European Central Bank (ECB) last week, as the former put a pause on rate hikes, while the latter upped rates by another 25 basis points.
Accordingly, the Fed kept interest rates in the official range of 5.00–5.25%, although the Federal Open Market Committee (FOMC), which is the Fed’s governing body and determines the direction of monetary policy, believes that two more interest rate hikes are needed in 2023 to reach a range of 5.50–5.75%.
In a recent monetary policy report, MAPFRE Economics, MAPFRE’s research arm, explains that the inflation data released in recent months “denote premature progress that is not sufficient to sustain the pause, despite positive real interest rates, the June base effect, and the headwind from producer prices.”
Therefore, the interest rate cuts that investors expected this summer will not take place until 2024, and rates could remain high until 2025. The central bank made no changes to its asset holding reduction, with the monthly combined roll-off of US$60 billion in Treasury bonds and US$35 billion in MBS (Mortgage-Backed Securities), without offering any additional future guidance.
With the balance sheet reduction back on track, and as the Treasury is expected to rebuild its general account (TGA) once the debt ceiling deal is reached by depositing money at the Fed, further tightening of the money supply is expected, putting further pressure on banks.
“The Fed tilts its pause toward an environment of increased tightening, under mixed signals across the board: inflation moderating, but with core inflation showing some downward opposition; diverging activity across sectors of the economy, but expansionary; employment continuing to imply wage pressures; and a less gloomy outlook for banking instability,” affirms MAPFRE Economics.
Economic activity remains weak, and the outlook for the future is even weaker, thus confirming the slowdown in the US economy. Meanwhile, the labor market continues to show imbalances.
“All in all, the second half of the year is leaning toward an extension of the expansionary cycle subject to a higher-than-expected terminal rate, with an additional 25 basis points expected next July and an additional 25 that could well be signaled for August or September at the upcoming Jackson Hole symposium. At that point, another pause is plausible to allow for a further assessment of the cumulative effect of monetary tightening,” the report details.
The ECB stays the course
The ECB raised interest rates by 25 basis points to 4.25% for the marginal lending rate, 4.00% for the main financing rate, and 3.50% for the deposit facility. The consensus expects more rate hikes during the year and confirmation of a latent stagflationary scenario.
“Two additional interest rate hikes of 25 basis points are expected in July and September, thus prolonging the optionality of reaching a higher terminal rate before the end of the year,” points our MAPFRE Economic Research.
As for the balance sheet, the ECB is continuing to reduce its security holdings through the Asset Purchase Programme (APP), at a pace of €15 billion through the end of June 2023, unlike reinvestments under APP, which will be discontinued as of July.
After revising the data for the first quarter, it is clear that the Eurozone is indeed immersed in a slight technical recession. The most noteworthy divergences are in the manufacturing industry, which is weighed down by the energy shock and the loss of competitiveness, and in the services sector, which is in a later phase of expansion. Added to this is the fall in consumption, which in the end could not be compensated by energy saving measures, fiscal support, or the strength of the labor market. Inflation data is not particularly positive either.
“The outlook in the Eurozone remains weak, although overcoming the prospect of a deep recession and chronicling certain risks which to date have been overcome with some success, but which leave no room for complacency,” explains MAPFRE Economics in the report.