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Latest News from Tatton Investment Management: Central bank Scrooges cancel Santa rally

16 December 2022

This week’s edition of The Tatton Weekly presents our outlook for 2023, which we compiled over the past two weeks. Inevitably, much of what we write depends on the starting point, given that this has been an exceptionally volatile year, we opted to leave our prognostications as late as possible. This seemed a prudent stance, given the past week contained the year’s last inflation data and interest rate decisions, the information that has dominated market movements through 2022. 

Despite our best efforts, there were some last-minute surprises handed to us.  

In our outlook, we say our expectation is that it is too early for the developed world’s central bankers to say the battle against inflation is nearing an end even though year-on-year inflation has started to move off the peak. Inflation rates published this week show that they may have peaked in aggregate but consumer prices are still heading generally higher, which is likely to also keep inflation overall higher for longer.  

As expected, many major central banks raised rates this week and told us they had more to do next year. In our outlook we say that the markets will be surprised in 2023 by continued central bank hawkishness, but some of that surprise already happened on Wednesday and Thursday. 

Wednesday’s US Federal Markets Open Committee meeting delivered the expected 0.5% rate rise with a slightly hawkish, slightly confusing message from the statement and chairman’s press conference. Thursday saw an even bigger hawkish surprise from the central banks’ messaging, rather than rate rise decisions. Again, rates rose as expected by 0.5% in the UK, Eurozone, Sweden, Denmark, the Philippines and Mexico to name a few.  

The European Central Bank (ECB) took the deposit facility rate to 2% (the more widely quoted rate is the refinance rate which also rose 0.5% to 2.5% but that’s not the most important rate). The hawkish surprise was that the ECB’s economic research staff put in an inflation forecast which was substantially above expectations and is expected to guide rate setters higher in 2023 than had been anticipated. JP Morgan researchers told us they now expect the deposit rate to reach 3.25%, “which is a huge change from the 2.5% terminal rate we had in our forecast until now. The abruptness of this reflects the puzzling step-change in the staff’s [inflation] forecasts and that the Governing Council is taking this fully at face value. We are still minded to see the lower path of the staff’s inflation projections as more likely but, even if we are correct, the data won’t show up soon enough to strongly influence the ECB at the next 2-3 meetings.” 

As a response Eurozone government bond yields shifted sharply higher. Equity markets, which had been buoyed in recent weeks by a decline in pessimism over Europe, also took quite a hit. That followed on from a delayed mark-down after the Fed’s more nuanced, but generally more hawkish than expected messages. 

In the actual economy, company analysts’ earnings forecasts have stabilized after the falls from last month, however, we should not read too much into this since we are in the quiet festive season. The Purchasing Manager Indices indicate that demand for this month remains softish, especially in the US, which will keep a lid on earnings expectations for 2022’s last quarter but other, harder economic data is a bit more encouraging. Our feeling is that the quarter will be reasonably ok now that analysts have brought down both revenue and margin expectations after the Q3 results. A positive earnings season in January could prove to be a double-edged sword perhaps, since that might encourage more monetary policy hawkishness. 

Central bankers have perhaps been Santa’s little helpers for too long and have definitely not helped Santa provide a rally this year. They appear to have grown up and all become Scrooges. Ah well, those who have followed our thinking over the past weeks will know that we are neither surprised nor shocked my this week’s market reaction to the latest rumblings from central bankers. As we said before and is laid out in the 2023 Outlook that follows, things are looking up for 2023 but we are not quite out of the woods yet. 

This is our last full weekly of the year. We wish you all the merriest of seasons and the best of wishes for 2023. 

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