Market View

Inflation and interest rates: a rocky expedition

Over the summer months, given the more resilient nature of the US economy in the face of a swift hiking cycle, investors have priced in a soft landing for the world’s largest economy. 

Jeremy Sterngold
mountain and trees

When talking about the economic projections, airplane landing references are very much in vogue, whereby hard landing seems a much more palatable way of expressing the risk of a recession. While that is a cynical way of looking at it, from a visual representation of growth, the references surrounding landing makes sense. 

That said, central banks are keen to give a different visualisation of the policy path. For much of this year, they have tried to reinforce the “higher for longer” messaging. While this seems to have become more appreciated in recent months, this was previously ignored by markets. Although referencing the peak, the mountain analogies seem to have been expanded and appear to be a desired way to express the path forward

A few weeks ago, the Federal Reserve (Fed) held its annual Economic Symposium in Jackson Hole, Wyoming: the meeting hosted by the Federal Reserve Bank of Kansas since 1982. 

In 1983, the symposium focused on structural changes to the economy which was then followed by the causes of inflation the following year. 

Those talking points would not feel out of place over recent years and accordingly, this year focussed on the structural shifts in the global economy. 

In previous years, Fed Chair Powell delivered some market moving speeches. However, this year he opted to reiterate the need for flexibility and reaffirming the higher for longer message. Perhaps given the rise in real yields over the summer, Powell did not want to cause another geyser eruption (for markets) unlike the world-famous Old Faithful in neighbouring Yellowstone National Park.

Further to this expedition, last week the chief economist of the Bank of England (BoE), Huw Pill, spoke at a conference held by South African Reserve Bank. While cautioning of some inflation persistence, he provided a much clearer visual on policy. During his speech he referenced two types of hiking cycles. The first one being akin to the famous Matterhorn Mountain, implying sharp increases followed by fast falls of policy rate. The other one bearing closer resemblance to Table Mountain. He said that he favoured the latter, the most visual representation of higher for longer. Furthermore, this implies that he believes there is a much higher hurdle rate for further increases by the BoE. This message was given further support by Governor Bailey earlier this week who stated that the period when it “was clear that rates needed to rise going forwards” was now over.

Taking the visuals even further, central bankers have been climbing a steep mountain. The earlier phases of the climb proved easier but as they climbed higher, some rocks along the way came unstuck. The LDI (Liability Driven Investment) crisis and the US regional banking crisis spring most to mind. They continued higher still as they saw the next part was more stable. However, given the heights they climbed, visibility has become poorer, and they have to reassess more frequently if it is still safe to climb. In essence, the impact of previous hikes are showing signs of slowing the economy. While core inflation is still too high for comfort, they fear tightening further may risk more of a Matterhorn path with financial risks building versus the seemingly more controlled path of Table Mountain.   

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