Macroeconomics: Beware hawkish central banks

Financial markets have started 2023 firmly but investors should be wary as central banks remain determined to lower inflation to their 2% targets.

Source: Bank of Singapore, Bloomberg.

We expect the Federal Reserve to lift its fed funds rate by 25bps in February, March and May to 5.00-5.25% and then keep interest rates unchanged – even if the US suffers recession in 2023 – in order to continue reducing inflation back towards 2%. The first chart shows the Fed raised fed funds by more than 400bps last year to 4.25-2.50% to levels it estimates are far above neutral rates of 2.50% for the US economy. But overnight New York Fed President Williams said: ‘with inflation still high … it is clear that monetary policy still has more work to do to bring inflation down to our 2% goal on a sustained basis.’

Source: Bank of Singapore, Bloomberg.

Similarly, the European Central Bank – faced with inflation of 9.2% as the second chart shows – may raise its deposit rate by 50bps in February and March to 3.00% despite last year’s energy shock. ECB President Lagarde said: ‘inflation … is way too high. We shall stay the course until such time we have moved into restrictive territory for long enough so that we can return inflation to 2%.’

Source: Bank of Singapore, Bloomberg.

The Bank of England is also likely to hike its Bank Rate by 50bps in February to 4.00% given inflation is still above 10% in the UK as the last chart shows while the Bank of Japan may abandon its cap on 10Y bond yields after a new governor starts in April as inflation has hit 4.0% in Japan.

Thus, we see the major central banks continuing to challenge risk assets in the first half of 2023.

This article was first published by Bank of Singapore on January 20, 2023. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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