Words from our Head of Research, Christian Gattiker

If one more proof was needed to show that my childhood was dull, it was when I showed my teenage sons ‘Dinner for One’. They first gazed at me in disbelief and then decided this was the most dreadful way of spending a New Year’s Eve. Certainly, anything like slapstick comedy in a black-and-white recording is so yesteryear-ish, and yet rituals and stereotypes are so helpful in managing uncertain times. For example, in 2022, central bankers have been slamming investor confidence with brutal hawkishness at the end of each and every quarter.

Early on, we got the message: they are behind the curve. In fact, they were behind the curve during the whole past decade by overestimating inflation pressure with stubborn regularity in each cycle since the Great Financial Crisis. But, ironically, in the aftermath of the pandemic, they under-estimated inflation pressure. Yet who can blame them? Extraordinary times trigger extraordinary moves.

Sooner rather than later, it will dawn on them that they are behind the curve yet again. The reason is that US inflation rates are falling like a stone. This may not be visible in the official numbers, which have proved to be sticky. Yet if you look at the more agile producer price indices, the six-month change there is approaching 2% (annualised). In other words, the peak was reached in mid-year 2022, and the drop in rates is accelerating.

By the way, for those who believe inflation is back for good, this is something that will only be tested in the next upcycle for the economy, for structural inflation pressure tends to come in waves – as in the 1970s.

What does this mean for investors?

For now, it is not time to rush in, as central banks have hampered the year-end rally by their relentless tightening. So stay defensive and stick to quality until it dawns on everyone that inflation scares are overblown and growth risks take centre stage.

Words from our Chief Economist, David Kohl

Last week, central banks delivered the expected slower pace of rate hikes. The Fed hiked the range for the Fed funds target rate to 4.25%–4.5% and indicated that rates will rise further by the end of 2023 to above 5%.

Consensus is expecting rate cuts in 2023 after the upper bound of the target range peaks at over 5%. Our own assessment is that rates are already in restrictive territory, making additional rate hikes unnecessary to achieve the Fed’s mandate of price stability and full employment in the medium term. The hawkish guidance of the Fed for further rate hikes has prevented overall financial conditions from improving and is hurting growth in the coming year.

The ECB, which hiked the deposit rate to 2% and the main refinancing rate to 2.5%, also slowed the pace of rate hikes to 50 basis points, as expected. Similar to the Fed, the ECB’s indications that interest rates need to increase further at a “steady pace” is a rather hawkish message. This surprised financial market participants and weighs on risk appetite and general financing conditions. We acknowledge that the ECB has room to hikes rates once more to slow the economy and bring inflation down. We forecast a further moderation of rate hikes in the coming meeting to respond to slowing credit activity and lower inflation rates.

The Bank of England (BoE) surprised with a more dovish guidance, which increases the probability that this was the last rate hike in this cycle. The BoE slowed the pace of hiking rates to 50 basis points and lifted its policy rate to 3.5%, in line with market expectations. The BoE believes that the economy is already in a protracted recession and that inflation will decline in the coming months.

What about the future?

Uncertainty surrounding this decline is the main reason why the BoE could hike rates once more before ending its rate hiking cycle. The Swiss National Bank (SNB) also slowed the pace of rate hikes to 50 basis points, in line with expectations. The updated inflation projection surprised slightly on the upside by showing a more persistent inflation trajectory over the longer term. The fast decline over the short term, however, increases confidence in our forecast that the SNB will deliver a final rate hike of 25 basis points at its next meeting in March, bringing the policy rate to 1.25%.

Please note this is the last Research Weekly of the year. The 2023 edition will be available on 11 January. We wish you a happy holiday season and a good start to the new year.