Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett considers what recent data releases could mean for the interest rate hiking cycle in the US and explains why he will be closely watching the latest core PCE figures.

24 February 2023

The Federal Reserve (Fed) has raised interest rates by 450 basis points (bps) over the past 11 months and yet the latest data from the US shows payrolls growth at 500,000 and unemployment at the lowest rate since 1969. Further, retail sales are currently at all-time highs and based on CPI data released last week, core CPI and PPI in the US are reaccelerating. What does that mean? The bond market thinks it means that the Fed will have to do more. Over the past two weeks, we have seen two-year yields in the US go up by approximately 40 bps while 10-year yields have increased by about 30 bps. Terminal rates at the very short end of the curve have also repriced around 25 bps higher. Therefore there is some uncertainty that the glide path to the end of the interest rate hiking cycle in the US is in sight, leading some to question whether the Fed will have to do more. Equity markets appear less affected at this point, with both US and European equities slightly up for the month. Asia is marginally down but not significantly considering the bond market moves we have seen. The dollar is slightly stronger but again, it has not reacted dramatically. At this moment then, it appears that bond markets are becoming a little more fearful, while equities are reacting to relatively good data and the likelihood that a recession in the US has, at the very least, been postponed.

I am always slightly cautious when I see those moves up, especially in shorter-dated yields which drove so much of market performance during the course of 2022. We have had a few good months in markets but I believe the risk signs are growing. Further stronger data, particularly on the price side from the US, would be something to pay close attention to. Eventually, if the price data remains high in the US, this increases the risk of a hard landing because the Fed will have to do more. The key data release to focus on in that respect will be core PCE on Friday, which Chairman Powell will also be looking at closely. This week we also have some quite important earnings data from US retailers, including Walmart, Home Depot and DJX, particularly given the strength of retail sales last week.

This week also marks the one-year anniversary of Russia’s invasion of Ukraine. President Biden was in Kiev earlier in the week and then travelled to Warsaw. We will be watching for any Russian response to that, particularly given the news over the weekend around Antony Blinken’s meetings with China which did not go particularly well. Blinken advertised the prospect that China may be beginning to supply Russia with more lethal force support; this would clearly be a negative and it is a geopolitical risk that warrants attention, even if right now and most likely for the next few weeks, it will not be an immediate market mover.