Weekly economic update: The hawk has fledged

Weekly economic update from Rupert Thompson, IBOSS Chief Economist, part of Mattioli Woods, where he analyses market reactions to recent events and identifies upcoming market trends in global markets, including in equities, fixed income, FX, etc.

In today’s piece, Rupert looks at:

• In the US: Fed Chair Kevin Warsh confirmed his new hawkish persona. The Fed voted in a unanimous decision to raise rates for the first time since 2023 by 0.25% to 3.75-4% and a large majority of the committee is forecasting at least one more rate hike this year.  As for the market, it is now forecasting slightly higher rates than before the meeting and expects them to be raised another 0.75% by next summer. IBOSS believe rates will end up being raised rather less than this – assuming energy prices are not still at current levels in six months’ time.
• In the UK: The Bank of England, as widely expected, left rates unchanged in a 6-3 vote for the second meeting running. However, it strongly suggested a rate hike was on the cards for their next meeting on Bonfire night with headline inflation now expected to reach 4% early next year. The market now believes the BOE will end up raising rates by a full 1% by next summer which IBOSS finds to be too pessimistic.
• In Japan: The BOJ meeting raised rates as expected by 0.25% to 1.00%. The BOJ implied rates had further to rise – and the market is pricing in another 0.75% increase over the coming year – but not as forcefully as had been hoped and the yen duly unwound some of its recent recovery.
• Diesel and Gas: Boosted by the loss in Russian refining output, diesel is now testing £2.00 in the UK and hitting new highs in the US, exacerbating Trump’s problems ahead of the mid-term elections on 3 November.
• This coming week: The Xi-Trump meeting on Thursday will be the highlight. Business sentiment data for the US, Eurozone and UK on Wednesday will also be closely watched to see whether recent gains in confidence were sustained in September.

The hawk has fledged

Central banks were front and centre for the markets last week with the US Fed, Bank of England and Bank of Japan all meeting. In the event, the market reaction to the central bank fest was fairly limited.

Global equities ended the week unchanged in local currency and up 0.8% in sterling terms. Most markets posted small gains in sterling terms with the US faring best with a 1% gain on the back of a stronger dollar and Europe continuing its recent run of underperformance with a 1% decline.

Following the recent rise in government bond yields to 20-year highs, the potential reaction from bonds was more a source of angst. But here too there were no big moves. The crucial 10-year US Treasury yield ended the week up very slightly, bang on the psychologically important 5.0% level, while the 10-year UK gilt yield fell back a bit to 5.30%.  US Treasuries were flat on the week while UK gilts returned 0.9%.

As ever, the Fed meeting was the most important and Chair Kevin Warsh took the opportunity to confirm his new hawkish persona. The Fed voted in a unanimous decision to raise rates for the first time since 2023 by 0.25% to 3.75-4% and a large majority of the committee is forecasting at least one more rate hike this year.

Warsh described the hike as removing a dose of accommodation, suggesting he doesn’t believe policy is currently restrictive. And he didn’t mince his words on inflation, saying ‘inflation is too high and has been for too long’ and ‘we must be confident that inflation is moving to our objective clearly and at sufficient speed’. The headline and core rates of the Fed’s favoured inflation measure currently stand at 3.7% and 3.3% respectively versus the 2% target.

Trump was surprisingly forgiving of his protégé’s bad behaviour in raising rates, blaming it on the bad company he is now keeping at the Fed, while still calling for rates to be cut to 1%. As for the market, it is now forecasting slightly higher rates than before the meeting and expects them to be raised another 0.75% by next summer. We believe rates will end up being raised rather less than this – assuming energy prices are not still at current levels in six months’ time.

As for the Bank of England, as widely expected, it left rates unchanged in a 6-3 vote for the second meeting running. However, it strongly suggested a rate hike was on the cards for their next meeting on Bonfire night with headline inflation now expected to reach 4% early next year.

The latest UK inflation numbers came in a touch lower than forecast, no doubt helping justify the MPC’s decision that no immediate action was needed. Headline inflation edged up to 3.1% in August but the core rate was unchanged at 2.6%, easing worries of second round effects from the surge in energy prices. The weak labour market also continues to keep earnings growth subdued with private sector regular wage growth of 2.9% in July.

As with the Fed, the market now believes the BOE will end up raising rates by a full 1% by next summer which looks too pessimistic to us. The BOE also set out its plans for quantitative tightening and running down its gilt holdings over coming years. These involved selling rather less longer-dated gilts and contributed to last week’s fall in 10-year gilt yields.

Lastly, we had the BOJ meeting which saw rates raised as expected by 0.25% to 1.00%. The BOJ implied rates had further to rise – and the market is pricing in another 0.75% increase over the coming year – but not as forcefully as had been hoped and the yen duly unwound some of its recent recovery.

Elsewhere, the Brent crude oil price rose mid-week to close to $110 per barrel but is back down to $102 this morning, partly on the back of news that oil flows through the Strait of Hormuz are seemingly holding up quite well despite the recent intensification of hostilities.

Attention recently, however, has swung more to diesel and gas prices. Boosted by the loss in Russian refining output, diesel is now testing £2.00 in the UK and hitting new highs in the US, exacerbating Trump’s problems ahead of the mid-term elections on 3 November. As for gas prices in Europe, if not the US, they are now well above their highs earlier in the year as a result of lower-than-normal storage levels ahead of the winter, even if they remain well below their peak back in 2022.

This coming week, the meeting of Presidents Xi and Trump in the US on Thursday will be the highlight. But business sentiment data for the US, Eurozone and UK on Wednesday will also be closely watched to see whether recent gains in confidence were sustained in September.