Contrary to our concerns, there was a tangible message from the Jackson Hole Symposium over the weekend. This was ‘higher for longer’ when it comes to the US Federal Reserve’s rate trajectory. Even the European Central Bank surprised to the upside in terms of rate projections.

While this commitment to do ‘whatever it takes to bring inflation down’ was more hawkish than most observers expected, the fact of the matter is that central bankers have delegated the job to the economy.

Data firmly in driving seat for monetary policy

In other words, the policy is data-driven, and whatever data shows inflation going down the most will be taken as a sign of confidence that monetary reins will not tighten as much. So we are basically down to things like the flash portfolio managers’ indices and, most importantly, the US employment report this week to telling us where we are heading in terms of money supply. This makes forecasting an evermore uncertain endeavour, as there are major feedback loops between the economy and financial markets in between.

How do we expect central banks to act?

For now, we share the consensus view in terms of the length of the tightening cycle. This means the first rate cut would be only in 12 months or so in the US. However, we do not agree on the number and size of the hikes. Money markets are pricing in something to the tune of 4%, which is far above the neutral policy rate (slightly north of 3%) that we expect as a peak.

Quite timely at the end of the summer, central bankers’ risk appetite has cooled off with a splash. Profit-taking has set in even earlier, and we expect medium-term opportunities to emerge in many beaten-down sectors, such as software or life science tools. In software, the beating was epic in size and calls for some differentiation (see ‘number of the week’). As for the bulk of equity markets, the short-term opportunities may be somewhat outside of well-trodden paths.

Number of the week

A closer look at the central banks meeting

The symposium in Jackson Hole made it clear that central banks remain committed to hiking rates to bring inflation down. This further tightening of monetary policy increases the headwinds for economic growth, particularly in 2023. The Fed has hiked its policy rate already quite considerably and the Fed funds target range is, with 2.25%–2.5%, close to a level that can be viewed as neutral. Another bold rate hike in the upcoming Federal Open Market Committee (FOMC) meeting either by 50bps or 75bps would bring the Fed funds target range fully into the neutral range.

Jerome Powell’s message at Jackson Hole was that the Fed stands ready to hike rates even to the point where economic growth slows below potential and job growth reverses. We expect this point to be reached by the end of this year, when the Fed funds target range is 75bps higher than today. While the probability has increased that the Fed will hike rates again by 75bps at the next FOMC meeting to slow the economy and ultimately inflation without further delay, we stick to our view that the Fed will prefer to proceed in a more data-dependent way starting at the next meeting.

Weaker activity data, including a softening labour market and another decline of the upcoming inflation rate, should pave the way for slowing the pace of rate hikes to +50bps in September and +25bps in November. A reversal of tighter monetary policy remains on the agenda but will happen later than previously anticipated. The Fed will hold interest rates higher until it sees significant progress in slowing inflation. We expect this to happen in the second half of next year, allowing the Fed to reduce its main policy rates only in September 2023.

What about the European Central Bank?

The ECB follows the Fed’s hawkish policy approach. The ECB governing council members who attended Jackson Hole signalled that more bold rate hikes are necessary to address high inflation even when it means more economic headwinds.

As the current level of interest rates is still well below a level that can be described as neutral, we expect the ECB to hike rates by 50bps at the upcoming September meeting and by another 50bps in October. The main refinancing rate would increase to 1.5%, a level that is closer to the estimates of a neutral rate than the current rate level.