Fed, ECB: mission not accomplished

The ECB has complied with the fashion of the day by raising its key interest rates by 0.75%, which implies a deposit interest rate of 1.5% instead of the negative rate of -0.5% that still prevailed at the end of June. Unsurprisingly, the ECB will continue to reinvest the proceeds from the redemption of bonds accumulated through the purchase programs (APP and PEPP). Widely expected, the ECB’s announcements received a quiet reception. The structure of interest rates in euros has even flattened, with long-term yields falling in line with the decline in dollar yields.

The official statement and Christine Lagarde’s declarations point to a slowdown in the monetary tightening cycle after the rapid adjustments made over the last three months. In contrast to the last few meetings, the ECB has not given any clear signals as to the path of its monetary policy, even though the stance is obviously restrictive. The ECB is navigating by sight and will make decisions based on the evolving outlook for inflation and economic activity. The “balance of risks” remains uncomfortable: on the downside for growth, on the upside for inflation (which reached 10.7% in October, 5% excluding energy and food).

In short, the ECB’s message is compatible with a rate hike limited to 0.5% in December, followed by a pause during 2023. The “terminal” interest rate, however, remains highly uncertain. Christine Lagarde has been totally elusive in her answers to questions about monetary interest rates peaking at around 3% (as currently reflected by futures on the 3-month euribor rate maturing next June).

After the ECB, the U.S. Federal Reserve is expected to raise the Fed funds rate on Wednesday by 0.75%, to a range of 3.75% to 4%. The FOMC statement and Jerome Powell’s press conference are not expected to reveal a specific roadmap, but will likely mention a change of pace justified by the tightness of monetary conditions after a cumulative interest rate hike of 3.75%. The Fed is expected to settle for a 0.5% increase in December, in line with the projections unveiled in September.

The “terminal” interest rate of 4.75% to 5% that is currently expected by investors would only imply a 0.5% increase in 2023 before a pause, a prelude to an eventual “pivot” that once again raises high hopes on Wall Street. The sharp decline in dollar yields observed last week is consistent with this logic, but this scenario is only weakly supported by economic developments that generally confirm the robustness of the US economy.

Real GDP growth in the US rebounded in the third quarter to an annualized rate of 2.6%. However, this recovery is largely attributable to the same vagaries of international trade (net exports) that caused GDP to contract in the first half of the year. The breakdown by expenditure item highlights a cooling of private domestic demand, and more particularly of residential investment, which testifies to the effectiveness of the monetary tightening conducted by the Fed. The persistence of inflation, confirmed by the rise in the consumer price index (0.5% monthly, 5.1% year-on-year excluding energy and food) and the drying up of the US labor market could force the Fed to raise interest rates above 5% before it can adopt a friendlier stance.