Markets remain in tension with rates continuing to rise on the expectation that high inflation will require more aggressive tightening from central banks but the riskier parts of the market are largely unperturbed for now. Communication from Fed officials through the week points to a front-loaded hiking cycle in the US through the remainder of the year in an attempt to put the brakes on inflation.
Fed underlines its hawkishness
If the message from last week's Federal Reserve meeting was that it was about to turn much more hawkish against high inflation, the point has since been amplified with larger rate hikes and a fed funds rate in restrictive territory under consideration. Uncertainty around the war in Ukraine held the start of the Fed's hiking cycle to a 25bps increase at last week's meeting but a speech from Chair Jerome Powell suggests the consensus on the FOMC is that more aggressive action is needed to restore price stability, including rate hikes of 50bps and raising the fed funds rate above the 2.4% neutral estimate. While acknowledging the challenges ahead, Chair Powell said that the strength of the economy gave the FOMC confidence it could achieve a soft landing, slowing inflation through tighter monetary policy while also avoiding a recession in the process.
Many FOMC members spoke publicly this week giving their individual views on the necessary path ahead for policy settings. Unsurprisingly, there is a wide dispersion of views on the matter, but there is consistency in the expectation that rates will need to head much higher through the course of the year. At the more dovish end of expectations are the Minneapolis Fed's Kashkari and the Atlanta Fed's Bostic, with both seeing the fed funds rate peaking below neutral at around 2% or just above. Aligning with the median view on the Committee for rates to rise slightly above neutral are the likes of the Chicago Fed's Evans and Daly from the San Francisco Fed. The more hawkish voices are the Cleveland Fed's Mester in calling for 2.5% on the fed funds rate this year ahead of further hikes in 2023, while the St Louis Fed's Bullard is arguing for the policy rate to hit 3% by the end of the year and for immediate action in reducing the balance sheet.
Rising inflation intensifies the headwinds to the UK economy...
With stronger-than-expected outturns driving UK inflation up to 30-year highs, headwinds to the growth outlook are intensifying with real household income set to contract sharply through the year. February's CPI readings saw headline inflation pushing up from 5.5% to 6.2%yr with the core rate also advancing from 4.4% to 5.2%yr. Further rises are to come with the data yet to reflect the impact of rising fuel and household energy prices following the Ukraine war. In this week's Spring Statement, the OBR revised its forecast for inflation to peak two quarters later and sharply higher at 8.7% in Q4 from 4.4% previously. The increased pressure this generates on household spending led to the GDP growth outlook this year being cut from 6% to 3.8%.
...prompting more fiscal support for households
To lessen the drag on the economy from higher inflation and previously announced tax increases, Chancellor Sunak's Spring Statement included £17.6bn of measures to support household budgets including a temporary cut to the fuel duty, tax relief, and energy rebates. The combined effect of these measures moderates the contraction in real household income by a third to 2.2% in 2022/23, though that is still set to be the largest fall in a fiscal year on record. On a more positive note, an increased tax take due to economic conditions outperforming previous forecasts meant that the government's cash requirement has been over financed by around £47bn in the current fiscal year, leading to a reduction in anticipated Gilt issuance in 2022/23.
Source: OBR
Euro area economy is showing strains from the Ukraine war
The risks posed to the euro area economy of slower growth and higher inflation from the war in Ukraine were highlighted in March's key PMI readings. Although still posting in the expansionary range (above the 50 level), growth had slowed over the month and existing supply chain and inflation pressures had intensified. Eased pandemic restrictions kept the expansion in the composite (54.5) and services (54.8) PMIs going, albeit with the pace easing back to the rates seen at the start of the year. Growth in the manufacturing PMI pulled back to a 14-month low at a 57.0 reading as export orders weakened sharply and output was hindered by delays in the supply chain with delivery timeframes lengthening out. The surge in commodity and energy prices pushed up the increase in input prices to record rates.
Source: S&P Global
Fiscal position to improve on the back of Australia's economic recovery
Next week's federal budget is expected to confirm a sizeable improvement on the deficit for 2021/22 from $99.2bn anticipated in the mid-year update. The Australian economy has rebounded rapidly from the Delta lockdown impacted Q3 where GDP contracted by 1.9%, leading to a faster fall in the unemployment rate while commodity prices have surged on the spillover effects from the Ukraine war. Indications from Treasurer Frydenberg are that some of the windfall will be used to fund targeted cost of living support with the rest to be directed at lowering debt with the economy having recovered to be more than 3% above its pre-pandemic level of GDP. This week, RBA Governor Philip Lowe in a public Q&A appearance said the Board was closely watching for signs that the low inflation "psychology" that existed in Australia in the decade prior to the pandemic was on the move as a result of recent price pressures.
