Daily Comment (January 26, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Today’s Comment begins with a discussion about whether central banks will continue to raise rates. Next, we explain why investors have varying opinions about the state of the global economy. We end the report with our thoughts about rising friction within the U.S.-led geopolitical bloc.

 Are They Done? Moderating inflation data and fears of a recession have led to calls for central banks to stop tightening; however, policymakers have pushed back.

  • Most of the G-7 central banks have resisted pressure from markets to change tack and stop hiking. After a report stated that policymakers were considering slowing hikes after their March meeting, European Central Bank officials decided instead to double down on the need to raise interest rates by 50 bps increments. Governing Council members Gediminas Šimkus and Joachim Nagel argued that the ECB should continue to raise rates in half-point increments throughout the year in order to contain inflation. Meanwhile, Fed policymakers, in the days leading up to the central banks’ one-week silence period, have urged markets to reconsider bets that the Fed could stop hiking as soon as June.
  • Global credit conditions are beginning to ease despite the rhetoric from central bank officials. The spread between the 10-year Italian and German bonds, a gauge for financial distress, has narrowed by almost 60 bps from its 2022 peak in October. At the same time, the average 30-year U.S. fixed-mortgage rate has fallen almost 100 bps within a similar period. The relaxation of borrowing costs partially reflects investor expectations that the lending environment may improve in the future.
  • The Bank of Canada’s decision to pause rate hikes after Wednesday’s 25 bps increase adds to speculation that central banks could be almost done tightening. It was the first of the G-7 countries to announce at least a temporary reprieve from its hiking cycle. This may force the Federal Reserve and the ECB, who are meeting on back-to-back days, to give more details about their policy path going forward. Equities could take a hit if policymakers signal that they are prepared to lift rates during a downturn. However, anything short of that may be favorable toward shorter-duration equities.

The Recession Debate: Warmer-than-expected weather, China’s reopening, and faster-than-expected U.S. GDP growth have made investors optimistic that a recession may be averted; however, there is still room for cautiousness.

 Bloc Battle: Rivalries are brewing between and within blocs as governments prepare for a less globalized world.

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