Equity markets were little changed over the month, but sentiment weakened. Interest rate expectations increased, and bond yields rose. The repricing of rates was initially driven by stronger data out of the US but was followed by disappointing core inflation numbers in Europe. Stronger economic growth and higher inflation led to speculation that central banks will need to tighten more aggressively.
The probability of the Federal Reserve ratcheting up the pace of interest rate rises, from a 25bps move in February to a 50bps at the upcoming March meeting, increased. Despite the recent rebound in the US economy there is considerable uncertainty on the impact of the recent aggressive interest rates increases on the US economy.
The US housing market has produced mixed signals lately, but new starts are falling, setting an ominous tone. The Fed will be loath to step up rate increases until it sees clearer indications of ongoing inflationary pressures.
The ECB faces a similar challenge with its preferred core inflation measure remaining elevated. The governing council has sounded more hawkish of late and is likely to retain its 50bp pace of rate hikes. This creates a dilemma for the Bank of England who have been less aggressive, but if both the Fed and ECB raise by 50bps they may feel obliged to follow suit.
The ‘Windsor framework’ is unlikely to ever set pulses racing but is another indication that UK political risk continues to recede. The agreement with the EU to dramatically simplify customs controls demonstrates a more technocratic, less ideological, approach to policy making and is likely to be sustained no matter who is in power.
Last Autumn’s UK bond market upheaval reminded politicians that, in a world of reduced financial repression, fixed income markets place significant policy constraints on government.