Starting with a bang
- 10 January 2022 (5 min read)
Key Points
- The Fed started 2022 with a clear hawkish message. The market impact of a swift reduction in the Fed’s balance sheet should not be understated.
- Italy and France open the debate on the reform of the European fiscal surveillance system.
Long-term interest rates started 2022 with a “bang”, reacting – rationally in our view – to a surprisingly hawkish batch of Fed minutes pointing to an early beginning of the reduction of its balance sheet. It may well be that the US central bank was increasingly frustrated by the curve flattening which had been the main market reaction to the telegraphed series of Fed Funds hikes. The stubbornly low level of 10-year yields threatened to “drown” much of the Fed’s intended monetary tightening.
Now that the market, a few days into the new year, has hit the interest rate levels we had been forecasting for the end of 2021, we want to question our forecast for the end of 2022 (2.0% for a US 10-year yield). We are not convinced we need to upgrade it. True, the latest data confirm the pace of wage growth is very high in the US, adding to the sense inflation is now largely endogenous over there, but with Biden facing more and more difficulties to achieve anything substantial on his latest tax and spend package – and the perspective of a Republican victory in the mid-terms – the US fiscal stance could turn quite sharply this year and next. In addition, while tapering is not necessarily the trigger of a correction of the equity market, a proper reduction in the size of the Fed’s balance sheet could be much more detrimental to risky assets. Given the sensitivity of the US real cycle to wealth effects, this is not something the Fed could completely ignore. So all in all we are inclined to stick to 2.0% by the end of 2022 for US 10-year rates, but with a significant risk that yields follow this year a “bell curve” and exceed these levels at some point in the first half of the year, especially if the expected slowdown in inflation is delayed.
While the hawks at the ECB continue to express their concerns over inflation, we think that for now the “status quo” of December 2021 can be maintained there, with the “big decisions” on policy rates pushed into the end of this year and more likely into 2023. However, the ECB is tapering its QE programmes in 2022, which reduces the support for the most fragile bond markets. As governments start preparing their fiscal bills for 2023 this summer and the European fiscal rules kick-in again next year, questions around debt sustainability may start to be asked. In this context, we take a good look at the proposal from Mario Draghi’s and Emmanuel Macron’s economic advisors for a reform of the Stability and Growth Pact.
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This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
All investment involves risk , including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested.
Disclaimer
This website is published by AXA Investment Managers Australia Ltd (ABN 47 107 346 841 AFSL 273320) (“AXA IM Australia”) and is intended only for professional investors, sophisticated investors and wholesale clients as defined in the Corporations Act 2001 (Cth).
This publication is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Market commentary on the website has been prepared for general informational purposes by the authors, who are part of AXA Investment Managers. This market commentary reflects the views of the authors, and statements in it may differ from the views of others in AXA Investment Managers.
Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
All investment involves risk , including the loss of capital. The value of investments and the income from them can fluctuate and investors may not get back the amount originally invested.