“Major Central Banks Approaching Terminal Interest Rates: When Will the “Pivot” Begin?”

These peaks are now leading markets to bet on when central bankers will begin a downward move, the famous “pivot” or “second pivot” after a pause, which they see starting this fall in the United States, and rather beginning 2024 in the euro zone.

What deadlines?

The perception of the road traveled and the risks or what remains to be done depends on many variables. “And also the mandate of each central bank,” recalls Paul Chollet, senior economist at Crédit Mutuel Arkéa.

“As the Fed is three-pronged (inflation-employment-financial stability), recent banking instability has implied a pause in rate hikes, although it will want to see the first effects on employment to confirm its pivot,” he continues, anticipating a stronger recession than that valued by the markets through the famous “soft landing”.

After Jerome Powell on May 3 acknowledged policy “perhaps restrictive enough”, BNP Paribas chief economist William De Vijlder studied economic data at a time when the Fed had stopped raising rates in previous cycles. .

“Experience shows that each tightening cycle is different, but the most obvious parallel is with the May 2000 shutdown, when labor market conditions were also very good and when, despite lower inflation and neutral financials, the Fed’s monetary policy committee (FOMC) was concerned about significantly tightened credit conditions for 25% of banks, compared to 46% in the last Bank Lending Practices survey”, explains William De Vijlder.

“Today, the challenge is huge given the inflation and employment data, but the Fed seems to be taking into account the accumulation of the hikes and the delayed effects,” he continues.

In the euro zone, the ECB has no direct mandate on employment, which may explain a more restrictive view, confirmed by the recent exits of governors such as Isabel Schnabel and Klaas Knot in favor of further rate hikes in view of the current data only.

The Frankfurt institution has nevertheless established since July 2022 a tightening just as unprecedented as in the United States (+375 basis points -bp- against +500 bp). If the deadlines for dissemination to the economy are established in theory between 12 and 18 months, current experience will provide the opportunity to verify them.

Economist Christina Romer, of the University of California-Berkeley, has just confirmed in a paper for the National Bureau of Economic Research (NBER) her January analysis that the maximum effect on unemployment occurred instead 27 months after the start of monetary tightening in the United States.

“Oxford Economics models give, one year after a 100 bp synchronized rate shock between the major central banks, a 0.2 percentage point (pp) drop in gross domestic product (GDP) in the United States” , says William De Vijlder.

“And 0.4 pp of GDP in the euro zone”, he specifies. This more marked effect in the euro zone is probably due to agents’ higher exposure to variable rates, through bank loans to companies and mortgage loans in certain countries, and to a more open economy which means that they are more strongly affected by the tightening abroad.

“Some people think that transmission times could be faster this time, but the savings accumulated by households and companies seem to be able to prolong spending and investments in the euro zone too”, nuance Samy Chaar, chief economist of Lombard Odier.

“In the United States, job creation continues to moderate, wages to decelerate, and underlying inflation in non-rental services even seems to be starting to slow down”, remarks Florence Pisani, director of research at Candriam . “The Fed now has a bundle of clues that logically pushes it to take a break, with no reason to quickly lower its rates,” she adds.

What risks?

The abandonment by the major central banks of forward guidance on their monetary policy has given way to the analysis of “spot” data. With the risk of misunderstanding the delayed effects of rising rates.

“There can be very heterogeneous effects, also linked to the levels of indebtedness of economic agents, and effects of poorly known thresholds at each new increase, a bit like for a racing driver who accelerates with each lap of the track”, continues William De Vijlder.

“We often talk about issues related to the confidence of economic agents (Pigou cycles): a company suddenly disappointed by overly optimistic expectations could decide, when financial conditions are tightening and productivity is falling at the same time, to stop its investments, with the induced effects on growth and even more on future employment”, explains the expert.

After a period of reopening, which is supporting consumption and still a little employment, BNP Paribas economists anticipate a moderate recession in the United States for the three quarters from July 2023 to March 2024. They are more pessimistic than the “soft landing” of the consensus. They therefore forecast cuts in the federal funds rate to 3.5% at the end of 2024, followed, with a quarter lag, by cuts to 2.75% at the ECB.

“The U.S. economy appears to be heading back to normal with the ongoing tightening, but like a marathon, the risk of a crash increases near the end of the run.

The ECB could also stop after the June increase (to 3.5% a priori), because a lot of information will come before the meeting at the end of July”, adds Samy Chaar. The economist anticipates, like the consensus, a return of the deposit rate to 2.75% at the end of 2024.

“The sharp rise in interest rates had an impact on the solvency of American households in 2007 because of mortgage loans at variable rates”, recalls François Geerolf, economist at the French Observatory of Economic Conditions (OFCE) and assistant professor at the University of California-Los Angeles (UCLA). “It seems to have more on the balance sheet of banks in 2023, a consequence of a risk transferred to these institutions which have made more loans at fixed rates. With real estate still as a sector more sensitive to the dangerous distortions implied by the policy money,” he added.

Florence Pisani evokes this subject in the euro zone, “where residential investment will be significantly slowed down, but with very heterogeneous situations to manage for the ECB”. Rates on new loans have risen significantly less in France than in Germany, and some countries such as Spain are still very exposed to variable rates. “The fall in energy prices and therefore also in inflation should restore some purchasing power to households in the second half of the year,” she adds.

“We share the idea that the decline in inflation could be stronger than expected in 2024 and that the euro zone is more exposed to variable rates”, continues Paul Chollet. “On the other hand, with a participation rate of 74%, the structure of the labor market leaves less leeway for the States to reduce the pressure on wages in the event of a new inflation shock compared to the United States, where the participation rate has been in structural decline for 20 years”. This explains, according to him, the fears expressed in the euro zone of a price-wage loop.

-Fabrice Anselmi, L’Agefi ed: VLV

Agefi owns the Agefi-Dow Jones agency

Agefi-Dow Jones The financial newswire

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