Joining the dots
The US Central Bank, the Federal Reserve, produces an interest rate ‘dot-plot’ which provides the outside world a guide to where the Federal Reserve believe interest rates will be in the future.
The current dot plot, or projection of interest rates is markedly higher than that being discounted by the bond market. Investors believe that the Federal Reserve will continue to raise interest rates in the next few months but then proceed to cut them later in 2023. The Federal Reserve policy projection is that interest rates will end up staying above 5% long into 2024.
Whilst investors believe interest rates will be heading lower in 2023, the Federal Reserve project that rates will be higher for longer
Source: Bloomberg, Artorius
The Federal Reserve has noted their concern that ‘misperceptions’ around their monetary policymaking, specifically around when they might start cutting interest rates, is fueling optimism in financial markets that would then “complicate the committee’s effort to restore price stability.” If the equity and bond market rally filters through to buoy consumer activity, then the Federal Reserve may have to deliver harder monetary policy than currently expected by investors to put the inflation genie back in the bottle.
With headline and core inflation measures falling back, the Federal Reserve may have grounds to wait and see if the current bout of wage inflation continues and feeds though to price inflation pressure later in the year. Despite the slowing economy, western economies have tight labour markets, which are driving up wages.
Wage inflation has eased off in the US, and this will be welcome. How this develops in coming months could be the key driver of interest rates in 2023 and beyond. After the pandemic hiatus to the economy which saw unemployment rate soar to nearly 15%, unemployment has returned to very low levels.
As can be seen in the chart below, wage inflation appears to have peaked towards the end of 2022, and the Goldilocks outcome of moderate wage inflation and continued low unemployment is unexpectedly within reach in 2023.
Goldilocks in the house?
Wage inflation appears to have peaked without any increase in unemployment for now
Source: Bloomberg, Artorius
The Federal Reserve is likely to want to see wage inflation moderate further before looking to step back from policy tightening.
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