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The ECB was surprisingly hawkish yesterday, hiking by 50bps (0.5%) and promising much more to come.


Didn't ever expect to hear those words, but we've seen this movie before...

The ECB getting hawkish just as economies are tilting towards recession...

The Ghost of Trichet will forever loom large over the ECB. Twice the ECB head tried to hike at precisely the wrong times. Firstly, heading into the 2008 recession and then again in 2011, when the sovereign debt crisis was already brewing nicely.

Now, the ECB is (finally) hawking it up in the face of 10% inflation, so it's worth asking if they're at it again... From Lagarde's Q&A 👇

It is pretty much obvious that, on the basis of the data that we have at the moment, significant rise at a steady pace means that we should expect to raise interest rates at a 50-basis-point pace for a period of time.
The second element that you have in this paragraph is the reference to a steady pace, so it’s significant, and it has to be a steady pace, which means that we have made progress over the course of the last few months, but we have more ground to cover. We have longer to go, and we are in for a long game.

Soooo many words. Anyway, markets got the message. Eurozone rates pushed higher...

And peak rate forecasts were upgraded...

GS: Today’s meeting reinforces our forecast that the Governing Council will hike by another 50bp in February and take the policy rate into clearly restrictive territory. But the hawkish communication also points to a higher hurdle for stepping down the pace of hiking than we had anticipated, especially as our inflation numbers are higher than the updated staff projections for the next few months.
We therefore now expect the Governing Council to hike by 50bp in March (vs 25bp before), 25bp in May (unchanged) for a terminal rate of 3.25% (vs 3% before). We do not expect any ECB cuts until 2024Q4, two quarters after the Fed.

Contrast that with today's commentary from the Eurozone flash PMI's 👇

“The outlook for inflation is especially encouraging, with supply chains now improving for the first time since the pandemic began and firms’ costs growing at a sharply reduced rate, feeding through to lower rates of increase for prices charged for both goods and services.”
“The downside is that this improving inflation outlook is primarily a symptom of falling demand, which has removed pricing power from many companies and their suppliers, and the business environment remains one in which confidence remains very subdued by historical standards. Thus, while the downturn is looking likely to be less steep this winter than previously anticipated by many, there remain few signs of any meaningful return to growth evident as 2022 comes to an end.”

Demand falling, inflation improving, no signs of a return to growth = recession in waiting.

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In France, interest rates were already becoming an issue. Even before the latest ECB hike yesterday.

“We’re also seeing the impact that higher interest rates are having on the economy, with some firms attributing this as a factor behind lower business activity.”
“Based off the latest survey results, we’re likely to see French GDP contract in the fourth quarter, which will raise the risk of a technical recession being confirmed in 2023.”

So, that's the ECB getting all hawkish into the likely recession. How bad any slowdown will be remains an open question.

Across the Atlantic, the Fed's way ahead at 4.5%. Dropping down to 25bps hikes looks to be the preferred option now as long as inflation keeps falling...

Markets are looking even further ahead, pricing in rate cuts for next year, ignoring the Fed's forecasts of higher for longer throughout 2023.

This quote from the WSJ article sums the sentiment up beautifully

“It’s like the new projections didn’t happen, quite honestly. And I’m surprised the market is shrugging it off so confidently,”
“The expectation is the economic data will be so poor” by the end of the first quarter “that the Fed will stop hiking.”

If that's the case, stocks are likely to suffer in the interim. Inflation coming down, while cash rates keep going up means increasingly positive real yields just for holding cash. Why risk in stocks now when you can wait for the cuts...?

The Nasdaq is already down by over 8% from Wednesday's post-Fed peak. Germany's Dax has dropped by around 5%.

There's still no real clarity on the future. The consensus seems to be that inflation's becoming less of a problem, and central bankers may have already done too much, meaning that a recession is all but certain.

But consensus isn't really the right word... The split between the Bank of England policy-makers was another microcosm of disagreement about what's currently happening.

Two voted against rate hikes altogether. Six voted for a 0.5% hike and one voted for a 0.75% hike. They all have the same data, but wildly different views stand out among the MPC members. Best of luck figuring that one out...

My money's on a messy landing rather than a soft or hard one. It's not hard to imagine this infuriating outcome 👇

Inflation drops, so economy picks up a bit, causes inflation to tick a little higher again, markets lose faith in the rate cuts... Economy slows some more, inflation drops... and we do it all again, eventually arriving at whatever the final equilibrium will be.

Energy could still play another role in all of this too. The only certainty for 2023 is uncertainty.