Welcome to the last weekly macroeconomic round-up of the year, where we spotlight a few of the most significant events in the last week.
US Federal Reserve increases the rate of tapering with rhetoric increasingly hawkish
Following the meeting of the Federal Open Market Committee (FOMC), Chairman Jerome Powell communicated the decision to increase the rate of asset tapering, winding down the rate at which the central bank buys fixed income securities. This is the first step towards the tighter monetary policy to tackle consumer inflation and was well signalled by the Powell administration ahead of the move. In addition to the increased rate of tapering the Fed’s expectation for future rate hikes also increased such that they are now expecting the headline interest rate to reach 2.5% by the end of 2023.
However, despite the obvious hawkish tilt compared to a month ago, uncertainty surrounding Omicron has meant that investors have brought down their expectation for long term interest rates. The US 10-year yield has fallen from roughly 1.65% to less than 1.40% in the last month. Aside from Omicron uncertainty, which likely remains a short-term obstacle, the other implication of a lower US yield is that investors believe that a more hawkish central bank will tighten policy more than expected, tackling inflation but also dampening growth, bringing down the terminal interest rate.
Peoples Bank of China (PBOC) cuts interest rates to combat slowing domestic growth
The PBOC cut its lending benchmark one-year Loan Prime Rate (LPR) from 3.85% to 3.80%. Although the magnitude of the cut is relatively small, it signals the intent of the central bank to ease financial conditions in an effort to support slowing economic growth. Recurring data from the past 6 months has shown the deterioration in economic activity in China, linked to slowing property market activity, repeated Covid linked shutdowns and a government regulatory crackdown. Crucially, the five-year LPR rate, which is used for pricing home mortgages, was held steady. This reflects policy makers concerns about the levels of leverage in the property market, illustrated earlier this year from the Evergrande debt default.
ECB concludes to reduce asset purchases but rules out raising interest rates next year
The European Central Bank communicated that it would bring its €1.85tn Pandemic Emergency Purchase Programme (PEPP) to an end over the next 3 months to March. However, to offset this falling liquidity, the central bank announced that the previous Asset Purchase Programme (APP) would be increased in the second and third quarter of 2022 and then maintained at its current run rate of €20bn “for as long as necessary”. Similar to the US, Europe is experiencing inflation which is higher than the 2% target and withdrawal of stimulus is the first step into a normalisation of policy. In contrast to the US however, the ECB has maintained that they will not raise interest rates next year.
Bank of England raises rates 0.15% in an effort to tackle inflation
The UK BoE became the first major central bank to hike rates last week, lifting the policy rate from 0.1% to 0.25%. This removes the emergency rate cut implemented in March of last year and paves the way for further tightening of policy over the next 12 months. The bank has previously committed to reducing its balance sheet of £875bn government bonds once policy rates reach 0.5%. This goes one step further than the Fed and ECB and would mean a net withdrawal of liquidity from the financial system rather than a decrease in net purchasing.
Markets
Global equity markets were down over the last week after rising Covid-19 cases, linked to the new Omicron variant, despite remaining near the recent highs. The increasing dispersion in central bank rhetoric and policy decisions led to divergent returns to government bonds; returns to European and US bonds were moderately positive while the surprising rate hike in the UK led to negatives returns. Reflecting the increasing chances of Covid-19 restrictions over Christmas, the oil price was down over the week.
We will return with more weekly market news in the new year, and wish you a happy and healthy festive season.
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