SPI Management Newsletter 22.09.23
Higher Interest Rates: A New Permanent Landscape?
The Federal Reserve recently indicated that interest rates might not decrease as much as previously anticipated, hinting at a long-term landscape of heightened rates. This subtle shift has implications for investors, businesses, and homeowners whose decisions rely on the trajectory of interest rates.
The neutral rate, which stabilizes inflation and unemployment over time, appears to have risen. Factors like demographics, global capital demand, government debt levels, and perceptions of inflation and growth risks determine this rate. Historically, if prevailing rates didn't temper demand or inflation, it suggested that the neutral rate was higher. Federal Reserve Chairman Jerome Powell acknowledged that the persistent strength of the economy and job market, even with rates between 5.25% and 5.5%, might be because of an elevated neutral rate. However, he cautioned that this is still uncertain.
Before the financial crisis between 2007-09, the neutral rate was believed to be around 4% to 4.5%. Due to prolonged sluggish growth and sub-2% inflation in the years following the crisis, this estimate fell. As of the latest meeting, the median prediction remains 2.5%, but an increasing number of officials believe it might be 3% or more.
Several factors could be elevating the neutral rate. Post-financial crisis, as entities focused on reducing debt, this limited growth and inflation. With the diminishing impact of the crisis and rising federal debt (now 95% of GDP), interest rates have experienced upward pressure.
Some downward pressures remain on the neutral rate, such as the world's aging population, which curbs demand for housing and capital assets. However, the current consensus suggests a shift to a higher-rate environment. Like any forecast, this might change depending on various economic outcomes, but for the time being, the public might have to adjust to this new interest rate reality.
Bank of England Pauses on Rate Hike, Diverging from European Counterparts
For the first time since November 2021, the Bank of England (BOE) held its key interest rate steady at 5.25%. This decision, deviating from the trajectory of some European central banks that recently escalated their rates, led to the pound depreciating 0.8% against the dollar.
The BOE's choice came on the heels of data revealing U.K. inflation dipping to 6.7% in August, down from 6.8% the previous month. This occurred despite rising energy costs and amidst indications of a weakening economy.. Concurrently, core inflation, which omits volatile components like food and energy, also registered a decline, marking its lowest level since January.
BOE Governor, Andrew Bailey, while acknowledging the declining inflation, cautioned against complacency. He underscored the necessity to remain vigilant and ensure that inflation gravitates back towards its 2% target, leaving room for potential future rate adjustments.
Navigating the intricacies of rate settings is intricate, as central banks worldwide grapple with setting rates that mitigate inflation but don't overburden economic growth. The economic terrain is further complicated by surges in oil prices, which could reignite inflationary pressures. Given the looming shadow of potential recession across European economies, the prospect of businesses passing on these escalating costs to consumers appears increasingly dubious.
In response to criticisms about previous underestimations of inflationary trends, the BOE has commissioned former Fed Chair Ben Bernanke to review its forecasting approach. Moreover, the BOE disclosed its intention to accelerate the reduction of its government bond portfolio, which was amassed during initiatives to stimulate the economy during global crises in previous years.
In an unexpected move, the Swiss National Bank kept their rates unchanged, causing the Swiss franc to dip by 1% against the dollar. Conforming to expectations, Turkey's central bank raised its rate to 30%, causing the lira to weaken, Sweden's Riksbank and Norway's Norges Bank increased rates as anticipated and Japan did not raise rates.
Adapted from WSJ, FT, NYT, Reuters, CNBC, Bloomberg