Rate Cuts Are Not On The Horizon Any Time Soon, Only The Bank Of Canada Appears To Have Already Ended Its Tightening Cycle
Aa
Share
Major central banks to bring hike cycles to a close
We think that the aforementioned easing in inflation rates should herald an end to interest rate hikes for most of the major central banks in the first half of 2023. We think that the Federal Reserve will be done raising rates after its March meeting. At its final meeting of the year in December, the Federal Open Market Committee (FOMC) took its first baby steps towards ending its aggressive interest rate hike cycle, delivering a 50bp rate hike following four consecutive 75bp moves. In its ‘dot plot’, committee members indicated that an additional 75 basis points of hikes may be on the way this year, though futures are only pricing in 50. The key message was that rate cuts are not on the horizon any time soon, and are not expected until 2024.
In our view, both the European Central Bank and Bank of England will follow suit in ending their respective hiking cycles in mid-2023. The ECB was the most hawkish of the three major central banks in December, as it announced a start date for quantitative tightening, while President Lagarde warned that multiple additional 50bp rate increases may be on the horizon. Meanwhile, we have little doubt that the Bank of England will continue to confuse markets this year, a hallmark of its communications in 2022. The BoE also raised rates by 50bps during its final meeting of the year, although the three-way voting split among MPC members provided little clarity to investors.
We believe that the Reserve Bank of Australia, Swiss National Bank, Riksbank and Norges Bank may only have one or two more hikes left in them, while the Bank of Canada appears to have already ended its tightening cycle. The Reserve Bank of New Zealand is expected to be the most active central bank in the G10 in 2023, with markets finally beginning to price in a long-awaited rate hike from the Bank of Japan in the second half of the year.
On the whole, most emerging market central banks are slightly ahead of their major counterparts and, for some, attention may soon turn to the timing of interest rate cuts. For many developing economies, inflation has, however, become deeply entrenched, and that may ensure higher rates for longer, a delayed pick-up in economic activity and a higher risk of default.
Read next: Intentional Depreciation Of The Currency - Devaluation| FXMAG.COM
Global downturns on the way?
As inflation rates begin to trend lower, and central banks globally press pause on their hiking cycles, attention among market participants will increasingly turn towards the possibility of recessions. We have already seen signs of a deterioration in most indicators of economic activity. The G3 business activity PMIs, which provide the most timely gauge of growth in the services and manufacturing sectors, have printed below the level of 50 representing contraction. Indicators of consumer, business and investor sentiment have declined, as have a number of barometers of consumer spending activity.
Generally speaking, we think that downturns in 2023 will be rather mild, and we’ve not seen any evidence in the data just yet that would indicate sharp recessions are on the way. We see a number of reasons to be optimistic about the global economic outlook, and believe that the pending downturns in activity won’t be as bad as currently expected by markets:
- Energy crisis fallout set to be limited. Natural gas prices have eased sharply, as shortages of natural gas appear unlikely this winter.
- Supply chains are normalising. Freight rates have declined almost back to pre-covid levels, with the impact of the war in Ukraine set to be less onerous in 2023.
- Inflation appears to be peaking in a handful of economic areas, as are interest rates.
- Labour markets are strong, characterised by very low unemployment rates, high job vacancies and solid nominal earnings growth. As of yet, we have seen little signs of a deterioration in labour market conditions.
- Households are well placed to withstand high prices, particularly given the extent of government support (fiscal policy remains supportive with no tightening in sight) and high savings accumulated during lockdowns.
- China is moving away from its zero-COVID policy. The country continues to lift its draconian restrictions as it prepares its society for living with the virus.
In our view, the end to central bank interest rates hikes, and the possibility that downturns in global activity won’t be as bad as currently anticipated, provide a conducive environment for an appreciation in high-risk currencies. In anticipation of a dovish pivot from the Federal Reserve, the US dollar has shed around 8.5% of its value since its September peak. We think that this move has more room to run, and we are pencilling in advances in most currencies against the dollar, notably emerging markets, which we think remain broadly undervalued. The extent of these moves will likely depend on the resilience of economies to the pending downturn, and the timing of when central banks globally will both end their tightening cycles and begin cutting interest rates.
2022 was a highly volatile year in the foreign exchange market, and we suspect that 2023 will prove much the same.
Written by: Enrique Diaz-Alvarez, Matthew Ryan (CFA), Roman Ziruk, Itsaso Apezteguia, Eduardo Moutinho, Michal Jozwiak – Ebury’s Market Analysts
Source: 2023 FX Market Preview: Is a global recession on the way? (ebury.com)
