Global Central Bank Policy and Market Volatility

Overview: Andrew Sheets and Seth Carpenter discuss the global economy, central bank policy, and market volatility.

Central Bank Policy

• Central banks are intentionally raising interest rates to slow down their economies and bring down inflationary pressures.

• The FED had expected a few more hikes this year, but the data got stronger and Chair Powell opened the door to 50 basis point hikes.

• Central banks have not seen evidence that things have gone so far that they're going to cause a recession.

• The market is now pricing in significant rate cuts through the end of the year and a scenario where the FED has gone too far and has to reverse their policy quickly.

Inflation and Monetary Policy

• Central bankers are still hyper focused on inflation being too high and the need to bring it down.

• Bank funding costs have gone up, compressing net interest margins and affecting credit extension.

• The FED is in a fine-tuning version of the world where they have to feel their way to the right degree of tightness.

• There is a path for central banks to ease, but it is not the baseline scenario for this year.

• Changes in monetary policy that tighten Financial conditions probably affect the real economy with a lag of two to four quarters, and from the real side of the economy to inflation there's probably another lag of two to four quarters.

Central Bank Interest Rate Hikes and Banking System Developments

Overview: This section discusses the effects of central bank interest rate hikes on the banking system, as well as the potential implications of recent developments in the banking sector.

Central Bank Interest Rate Hikes

• The central bank is planning to hike rates until the end of 2025, which is a long time horizon.

• Even before the recent developments in the banking sector, deposits were coming down in the US and loan growth was slowing.

Banking System Developments

• The real question is whether the banking sector will experience incremental or discontinuous tightening of financial conditions.

• Central banks are trying to tighten financial conditions in order to slow the economy and bring inflation down.

• There is no dichotomy between focusing on inflation and financial stability.

Navigating Turbulent Waters

• Despite the volatility in the narrative and data, the core message is that 2023 will be a year of decelerating growth in the US and Europe.

• Investors should be prepared for a decelerating growth environment by owning less equities and more bonds than normal.

• It is important to work closely with the global economics team to navigate these turbulent waters.

• Investing should follow patterns similar to other periods of significant deceleration.