High rates start to bite?
Whilst the rest of the world has struggled to generate upbeat economic data in 2023, the US economy has grown by more than expected. This positive outcome has not resulted in higher inflation.
However, interest rates have also risen by more than expected as the Federal Reserve wants to bring the rate of economic growth down to dampen the potential for inflationary pressure in 2024.
Higher interest rates and increased borrowing from the US government, which has run a larger than expected budget deficit in 2023, have combined to push bond yields up to multi-decade highs.
Higher bond yields will curtail the economy especially when borrowers must refinance their current debt, which will be the case over the coming years.
The trend of lower interest rates over the past 40 years has been a contributor to the higher profit margins enjoyed by companies and equity investors alike. This is likely to reverse as interest rates may be higher for longer. This increased cost burden is not yet reflected in forecasts for companies’ profits in 2024.
US economic growth surprise
US economic growth has turned out to be stronger in 2023 than forecast. The resilience has been striking given the increase in interest rates and the headwinds of weak economic growth in Europe and China.
Economic growth has been stronger in the US than economists had expected.
Source: Bloomberg, Artorius
One of the consequences of the better than expected US economic data, is that interest rates have increased by more than either the market and even the Federal Reserve had suggested at the beginning of the year. Markets had priced in a peak in interest rates in the middle of the year and some rate cuts by now but instead there are questions over whether interest rates may go even higher.
The US Central Bank, the Federal Reserve, produces an interest rate ‘dot-plot’ which provides the outside world with a guide to where the Federal Reserve believes interest rates will be in the future. Investors believed that the Federal Reserve would continue to raise interest rates in the first few months of 2023 but then proceed to cut them by now. The Federal Reserve policy projection was that interest rates would end up staying above 5% long into 2024, but not increase by as far as they have done. This is striking because inflation has turned out more or less in line with the start of the year forecast.
In 2023, interest rates have risen by more than the market had discounted and further than the Federal Reserve themselves had forecast at the start of the year.
Source: Bloomberg, Artorius
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