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  • Stronger-than-expected U.S. jobs and GDP data highlighted a key risk to the U.S. Federal Reserve taking its foot off the monetary brakes.
  • Economic strength and persistent labor market tightness can put significant pressure on wages and inflation, which threatens to become entrenched.
  • Patrick Armstrong, the chief investment officer of Plurimi Group, told CNBC last week that there is a two-sided risk in the current market situation.

Traders react as Federal Reserve Chairman Jerome Powell makes comments on screen on the floor of the New York Stock Exchange (NYSE) in New York City, March 22, 2023.

Brendan McDermid | Reuters

The market has long been selling interest rate cuts from major central banks until the end of 2023, but sticky core inflation, tight labor markets and a surprisingly resilient global economy are leading some economists to reconsider.

Stronger-than-expected U.S. jobs figures and gross domestic product data highlighted a key risk for the Federal Reserve to take its foot off the monetary brakes. Economic strength and persistent labor market tightness can put significant pressure on wages and inflation, which threatens to become entrenched.

The U.S. consumer price index cooled sharply from a peak of more than 9 percent in June 2022, falling to just 4.9 percent in April, but still above the Fed’s 2 percent target. Crucially, core CPI, which excludes volatile food and energy prices, rose an annualized 5.5% in April.

Chairman Jerome Powell hinted at a pause in the hiking cycle at the FOMC’s June meeting, when the Fed raised the fed funds rate from 5% to 5.25% earlier this month as it implements a 10-point interest rate hike starting in March 2022. .

However, minutes from the last meeting suggest that some members still see a need for further increases, while others believe that a slowdown in growth will prevent further tightening.

Fed officials, including St. Louis Fed President James Bullard and Minneapolis Fed President Neil Kashkari, have signaled in recent weeks that a sticky core inflationary stance will keep monetary policy on track for a longer period of time and that further hikes are likely to slow down significantly later in the year.

The personal consumption expenditures price index, the Fed’s preferred gauge, rose 4.7% year-on-year in April, new data showed Friday, pointing to further tightening and further bets on higher interest rates.

Several economists have told CNBC over the past two weeks that the U.S. central bank may tighten monetary policy to turn around stubborn volatility.

According to CME Group’s FedWatch tool, the market currently places a 35% chance of a year-end rate in a range of 5% to 5.25%, with a more likely range of 3.75% to 4% in November 2024.

Patrick Armstrong, the chief investment officer of Plurimi Group, told CNBC last week that there is a two-sided risk in the current market situation.

“If Powell goes down, it’s probably going to go down a lot more than the market value, but I think there’s more than a 50% chance that he’s going to be on hand, we’re going to go through the end of the year,” Armstrong said.

“Because the services PMI is incredibly strong, the employment background is incredibly strong, consumer spending is strengthening everything — unless there’s a debt crisis, the Fed doesn’t really need to put liquidity out there.

European stagnation

The European Central Bank faced the same problem when it slowed the rate hike from 50 basis points to 25 basis points at its May meeting. The bank’s benchmark rate was set at 3.25%, a level not seen since November 2008.

Inflation rose to 7 percent in April, even as core price growth showed a surprising slowdown, fueling further debate over the pace of inflation that appears to be returning to normal. Earth.

The euro zone economy grew by 0.1% in the first quarter, below market expectations, but Bundesbank President Joachim Nagel said last week that much more rate hikes were needed, even if this pointed to a recession in the bloc’s economy.

“We are in a phase that will not be easy at all. Because inflation is stuck and not going the way we all want, it’s important that the ECB remains open to further rate hikes as long as necessary, as Joachim Nagel said today. until the termination is complete,” former Bundesbank executive board member Andreas Domret told CNBC last week.

“Of course, this will have a negative impact on the economy, but if you allow inflation, I firmly believe. [de-anchor]If they let inflation go, those negative effects could be even higher, so it’s important for the ECB’s credibility that the ECB stays on track.

Bank of England

The UK has faced tougher inflation than the US and Eurozone, and UK consumer price inflation fell less than expected in April.

The annual consumer price index fell to 8.7% in April from 10.1% in March, beating consensus estimates and the Bank of England’s forecast of 8.4%. Meanwhile, core inflation rose to 6.8% from 6.2% in March, which will be a further concern for the Bank’s Monetary Policy Committee.

With inflation remaining stickier than the government and central bank had expected, now nearly double the equivalent rate in the US and sharply higher than in Europe, traders have increased bets that interest rates will need to rise to curb inflation. .

“Supply shocks, still persistent inflation, some promotional discounting and some potential margin building may keep prices from adjusting as quickly as traditional models,” said Sanjay Raja, UK economist at Deutsche Bank.

“We now expect a slower downward trend to target, and now that price and wage inflation may remain higher than expected, we raise our terminal rate to 5.25%. We think risk management issues will force the MPC higher and higher than previously thought.”

Deutsche Bank now sees its monetary policy moving “strongly” into a “high-term” period, Raja added.

According to Refinitiv data on Friday afternoon, the market is giving a 92% chance of a further 25 basis point hike from the Bank of England at its June meeting.

But while rates are expected to rise longer, many economists still see a full reversal later this year.

Berenberg had previously forecast three cuts by the end of 2023, but cut this to one in response to inflation last week.

The Bank of Germany is planning six 25 basis point cuts next year, leaving its call for a 3% rate at the end of 2024 unchanged, but in August it set a further 25 basis point rate hike of 30% to take on bank rates. about 5%

“Policy changes operate with uncertain outcomes and volatility. Because of the shift from floating-rate mortgages to fixed-rate products over the past decade, it will take longer than in the past to channel monetary policy through the housing market,” said Calum Pickering, senior economist at Bernberg.

“This highlights the risk that if the BoE overreacted to recent inflation, it could be setting the stage for a major inflation after the full effects of past policy decisions have played out.”

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