Market Musings 181222: How Long Can Consumption Resist Gravity?
Recession seems to be the consensus right now.
The question, in the short term, is:
“How quickly central banks led by the US Federal Reserve, will pause their series of interest rate hikes”
in the face of inflation rates that are high today, but are clearly coming down now.
For now, the consensus seems to be that the US Federal Reserve will likely raise rates for the last time in this cycle in February next year, and then go on an extended pause. This will allow the Federal Reserve to see the effects of the interest rate hikes they've already put in place, in terms of slowing both the economy and therefore inflation as well.
US, UK and Eurozone central Bank interest rates
Source: St Louis Fed
Note that medium-term inflation expectations, which we can observe by looking at the bond market, suggest that long-run inflation rate should remain relatively well behaved, i.e. not far away from 2%.
US 5-year expected inflation rate under 2.5%
Source: St Louis Fed
In Europe, we were a little surprised this last week to hear the European Central Bank talking tough, suggesting that the peak in Eurozone benchmark interest rates may be around 3%, above where we are today. The degree of surprise could be seen in the sharp surge in short-term German bond yields, which rose above 2.4% late last week.
German 2-year bond yield suddenly prices higher ECB rates
Source: tradingview.com
However, for me, whether the European Central Bank actually delivers on this threat/promise largely depends on the future course of energy prices in Europe over the next few months.
Which in turn depends on two things.
Firstly, on the supply side - how quickly we can receive more gas from the United States over the remaining winter months.
And secondly, on the demand side - by how much we can reduce our demand for gas and electricity in order to allow these prices to ease lower.
Today, gas and electricity prices remain at least four to five times above where they were at the beginning of 2021 in Europe. That represents a huge extra tax on the European economy, thus dragging down growth.
Dutch (European benchmark) gas…
