One central bank, two central banks, three central banks,…

On a strictly financial level, the news was marked by the resolutely less accommodating turn taken by the monetary policy of the ECB and the Fed, which resulted in a rise in long rates.

In recent days, the reactions on the equity markets have been made according to the news on the geopolitical situation with a particular interest on possible negotiations. Without trying to predict the outcome of these discussions, investors seem to be a little complacent about a quick resolution of the conflict. Perhaps this is just wishful thinking, but we don’t think it should guide short-term asset allocation decisions.

On a strictly financial level, the news was marked by the resolutely less accommodating turn taken by the monetary policy of the European Central Bank (ECB) and the American Federal Reserve (Fed), which resulted in a rise in long rates . At the close of March 17, the yield of the American 10-year T-note stood at 2.18% (+23 bp in one week; +36 bp compared to the end of February) and that of the 10-year Bund at 0.39%, the highest since mid-November 2018 (see graph). From one Wednesday to another, global equities regained 1.6% and lost only 2.1% compared to the end of February (MSCI AC World index in dollars at the close of March 16).

China: a Central Bank against the grain

While Europe is particularly exposed to this geopolitical crisis, the Omicron BA.1 wave is sweeping over Asia, reminding us that the health crisis is not quite behind us. The rise in the number of new cases of contamination in China has led to the establishment of strict confinements in Shenzhen, a city bordering Hong Kong, and in Changchun in the northeast of the country. Primary schools, middle schools, high schools and nurseries and kindergartens have been closed since March 12 in Shanghai. According to the latest report delivered by the Chinese National Health Commission (CNS), 1,952 symptomatic cases of local contamination by the SARS-CoV-2 coronavirus were identified on Tuesday March 15 in more than a dozen Chinese provinces and cities. While bearing in mind the exponential nature of the increase in the number of cases in this epidemic, these figures show that the zero Covid policy is not a pipe dream.

The Chinese authorities are aware of the effects of this strategy on growth and on the evolution of the financial markets (depreciation of the yuan, fall of the CSI 300 index to its lowest level since June 2020). In this context, the People’s National Assembly last week reaffirmed the GDP growth target of 5.5% in 2022 and the importance of “stabilizing” growth. This term implies in practice the implementation of fiscal and monetary support policies. Since the cut in key rates announced in January, the PBoC (People’s Bank of China) has maintained the status quo while continuing to ensure the liquidity of the banking system but should proceed with further easing. In addition, on March 16, Vice Premier Liu He made several statements in which investors detected the desire to implement policies favorable to the equity market and to limit regulations, particularly in the technology sector.

Elsewhere, monetary tightening is the order of the day

In this regard, the biggest surprises came from the ECB, which, following the March 10 Governing Council, presented conclusions that were much less accommodating than expected, when many observers considered that the geopolitical situation and the associated downside risk to growth would warrant a more cautious approach.

Of course, the deposit rate remained fixed at -0.50%, but the announcements on the rate of reduction in securities purchases were more aggressive than last December. The ECB confirmed the end of securities purchases under the PEPP (Pandemic emergency purchase programme) at the end of the month but the extension of the APP (Asset purchase programme), intended to limit the consequences of this cessation of purchases on the bond markets of the euro zone, will be more limited (+20 billion euros in April, +10 billion in May and return to the current rate of 20 billion in June). In addition, the ECB announced the end of this program in the third quarter and now mentions that the first rate hike will take place “some time after” the end of the net purchases of securities, and no longer “just after”.

These announcements have led observers to anticipate a first increase in key rates at the end of the third quarter or the beginning of the 4th and to consider the return of the deposit rate to 0% from the end of 2022. While we reviewed at the lower our growth forecast for 2022 (now at 2.8% against 4.2% previously) and consider that the risks remain downside while those on inflation are bullish and that it is indeed the idea of ​​inflation higher for longer (above 6% in the first half) which will prevail, we are maintaining our scenario of an initial increase in key rates in December 2022 and continued normalization in 2023.

While forward guidance (an indication of the future orientation of monetary policy) had been somewhat battered by the change in tone in a few weeks between December and early February, seeking to regain credibility on compliance with the objective of inflation could prove to be a winning strategy for the ECB. Ensuring greater “optionality” in the conduct of monetary policy by returning to decisions dependent on economic data could simplify communication in the coming months and avoid overinterpretations of the slightest inflection in the discourse.

A more predictable Federal Reserve than the ECB

Following the March 16 FOMC (Federal Open Market Committee) meeting, a widely anticipated 25bp hike in the US federal funds target rate was announced. Only the President of the Saint Louis Fed, who had distinguished himself by his more aggressive approach to monetary policy in recent weeks, voted for a 50bp hike. The graph (dot plot) which reflects the levels of key rates deemed “appropriate” by the members of the FOMC shows that 4 additional rate hikes are envisaged compared to the conclusions of December even though the forecast for GDP growth has increased from 4 .0% to 2.8% for Q4 2022 year-on-year. The Fed still forecasts a very low unemployment rate (3.5% at the end of 2022 and 2023, 3.6% at the end of 2024) and envisages that the measure of the inflation that it is monitoring in particular (core PCE, i.e. the deflator of private expenditure excluding food and energy) will stand at 4.3% in the 4th quarter of 2022 and 2.7% at the end of 2023.

The message is clear: even eroded by the consequences of the geopolitical crisis, domestic demand will remain very solid in the United States in the coming years and result in growth above its potential. In this context, inflationary pressures, which are not exclusively due to the rise in energy costs, largely justify starting a cycle of tightening of monetary policy, the pace of which could be accelerated as Jerome Powell. Moreover, the remarks of the Chairman of the Fed suggest that the “passive” reduction in the size of the balance sheet, ie the cessation of the reinvestment of the principal of maturing securities, could begin as early as April.

Even if questions about the consequences for activity of these less accommodating monetary policies will not take long to occupy the minds of investors, thus maintaining volatility, the rise in bond yields should continue, in the United States as in the eurozone.

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