Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
In some ways, we feel like we’ve been waiting for this moment for decades. It’s not a moment we’ve been looking forward to, but it is one which we felt was inevitable. A moment when central banks, or to be more precise the US Federal Reserve, cannot so easily ride to the rescue of financial markets. Something they have been doing since the “Greenspan put” back in 1985.
It’s not because of a change in philosophy or a principled stance to avoid adding to the layers of moral hazard of recent decades. It’s simply because they have a remit to keep inflation under control and, unfortunately, it remains elevated. As a result, Fed actions now have more complex implications.
Inflation was never dead forever, nor was it transitory back in 2021 and nor, we believe, will it obediently return to 2% and stay there, though it is falling from its peak. Nor, in fact, is inflation always best represented by consumer price inflation (CPI), though this is the metric the consensus narrative focuses on and, to be fair, it is the Fed’s official target.
However, much of CPI is driven by imported inflation, such as energy prices, rather than being domestically generated. The Fed has more control over domestically generated inflation and consistently talks about services inflation, much of which is driven by wages inflation. Services inflation stays elevated (see chart below), and the labour market remains tight on most measures. In short, much of the inflation metrics that the Fed cares about remain elevated.
Services inflation remains elevated
Source: Bloomberg, data from 31.01.2018 to 28.02.2023.
Of course, the Fed also cares about systemic risk to the financial system, or at least to the degree that it effects the US, and they will of course be concerned about recent stress in the banking system. To be clear though, it’s not a binary decision for central banks: it’s not necessarily a choice between reigning in inflation and mitigating banking system risk. Central banks have a range of tools available to them, above and beyond official interest rates, which they can use to help struggling banks.
That said, if rates stay high across the curve, albeit that they are lower than a few weeks ago, other areas will continue to come under stress, not necessarily just in the banking sector. For example, corporates are much more leveraged than financials in this cycle.
Indeed, hiking rates leading to stress is well proven in history, recent examples include the Fed hiking before the US housing collapse in 2008 and before the dot com collapse in 2001. The current situation has been characterised by one of the largest hikes in US interest rate history, with much of the lagged effects yet to be felt. Also, the yield curve stays inverted and it seems reasonable to assume that the yield curve leads lending standards, which in turn lead the economy.
It’s not clear where we are going, it rarely is, but it seems sensible to conclude that recent events add an additional dimension to policy risk, though the consequences might not be limited to the banking sector.
