So Little Cause For Carolings

By Martyn Page, Investment Director 

December 23, 2022

IN DECEMBER, the three main central banks (US, EU, UK) all raised interest rates by 0.5 per cent and all said there was more to come. Over the past two years these central banks have been proven disastrously wrong in their assessment of inflation. As a result, they have all been forced into the most front-loaded, fastest-paced cycle of interest rate rises for decades.

Consequently, financial markets face three serious challenges: inflation, rising interest rates (to reduce the inflation) and the growing risk of recession (a likely consequence of those rising interest rates). 

Nobody knows how this will play out. But if ultra-low interest rates, quantitative easing and forward guidance were meant to bring yields down, dampen volatility and encourage risk taking (which, in the previous decade, they were) then we can perhaps expect rising interest rates, quantitative tightening and no forward guidance to increase volatility and discourage risk taking. 


The US central bank raised interest rates by 0.5 per cent as expected but said nothing that surprised markets. Fed Chair Powell said that rates were likely to stay high but there is no reason to believe his attempts at such ‘forward guidance’ since his about-turn last June.

Our view: We’ve said the Fed is feeling its way towards the top of the interest rate cycle against a backdrop of an economy which is still growing strongly. More precisely, rather than having a secret number in mind, it looks to be targeting broader financial conditions. 

Well, the US housing market is already slowing, but the labour market remains tight. Every time the equity or bond markets rally, people feel richer and so financial conditions become a tad looser. The Fed is then minded to take interest rates higher. Recall that the US central bank has a dual mandate – not just stable prices with moderate long-term interest rates (both are tied to the two per cent inflation target) but also full employment under normal economic conditions. 

A tight labour market with 1.7 job openings for every person looking for work, means that second criterion is more than covered. The Fed’s focus on a tight labour market means it risks over-tightening for the rest of the economy. But, as of mid-December, the US stock market appears to be looking beyond that. If you expect company profits to take a hit in 2023 then this doesn’t feel right.

Bond markets are typically more sensible than equity markets. The US government bond market is saying something different to the equity market. If you lend money to someone who promises to pay you back in 10 years, you might well charge a higher interest rate then if repayment was just two years hence. However, the yields on long-dated bonds are now lower than the yields on very short-dated bonds. This is the opposite of what you would expect.

The newspapers will tell you this is called ‘an inverted yield curve’ and that it is the most reliable indicator of a recession coming down the line. What the lower yields on the long-dated bonds are telling you is that they expect short-dated yields to be much lower within 12-18 months. And the reason for that is typically because the economy will be in recession and the central bank has to cut interest rates quite a lot. Like Orla McCool in Derry Girls who shouts ‘Fire!’ when there isn’t one ‘because it gets more attention’, the inverted yield curve is not necessarily shouting ‘Recession’, it is simply saying – rather loudly – that it expects the Fed to be cutting interest rates in the next year or so. But it is not saying why. 

Of course, this is not what the central bank is saying. Chair Powell, the Buzz Lightyear of central bankers, says repeatedly that interest rates are going higher every time someone pulls the string in his back – although maybe not to infinity and beyond. So, we have a situation where markets don’t believe what the US central bank says. Clearly, they can’t both be right. 

In our view, the market is saying when the going gets tough (much later in 2023) the Fed will fold and start cutting rates. In Grand Old Duke of York fashion, having marched interest rates quite some way up to the top of the hill, the Fed has left itself plenty of room to march them back down again, as and when required. After all, it will have been the one that caused the recession. Set against this is the traditional advice of ‘Don’t fight the Fed’.


The Bank of England (BoE) increased interest rates from three per cent to 3.5 per cent. Six of the nine members of the Monetary Policy Committee voted for the half point rise while two voted for no change. These two wanted to wait and observe the effect of earlier increases, effectively prioritising short-term economic growth ahead of inflation control. Compared to November, the pound strengthened by 2.75 per cent against the dollar. A stronger pound acts a bit like higher interest rates. 

Inflationary pressures may be declining for some consumer goods, but food and non-alcoholic beverage price inflation was 16.4 per cent in November, its highest level in 45 years, and was expected to rise further. This mostly reflected global factors including adverse climate conditions, supply constraints caused by the war in Ukraine and rising energy and fertiliser costs in food production. Private sector regular pay growth picked up to 6.9 per cent, whereas annual public sector pay growth remained weaker, at 2.7 per cent in the three months to October. 

For mortgages, the BoE noted that lending rates for new fixed-rate mortgages were between 0.4 per cent to 0.8 per cent lower since its November meeting and that there had been some recovery in the number of mortgage products available. Set against this, banks had grown more cautious on loan sizes as they expected borrowers’ balance sheets to deteriorate. Lending volumes had decreased and approvals for house purchase had fallen below 60,000 in October, the lowest level since 2013, excluding lockdown. The volume of offers made on properties had declined below the normal season level according to Zoopla. Nothing in the above paragraph should surprise anyone. 

The governor of the BoE gave interviews where he said that although inflation was expected to fall more quickly in the Spring, the labour market was still very tight and so interest rates were likely to go higher.

Our view: The UK economy is much more sensitive to interest rates than the US. Here, interest rate policy has already tightened enough to put a stick in the spokes of the housing market, tax policy is tightening and quantitative tightening (taking money out of the financial system) is also raising borrowing costs. This latter point gets little or no covered in the newspapers but do not ignore its effects. In addition, the pound has been regaining some of its strength against the dollar – and this also tightens financial conditions. Put it all together and we think it puts less pressure on the BoE to keep raising rates over the medium term - rates may not have to go up much further. 

Inflation that is driven by expanding profit margins is obviously a lot less sticky than inflation that is driven by wages. The remarkably rapid collapse in prices of durable goods items provides supporting evidence that consumers are being squeezed tightly – we all know that real wages (ie after inflation) are sharply negative. It is hard to square anecdotal evidence of nurses using food banks and struggling to afford their tube fares to work with claims that a pay increase could trigger a dangerous wage-price spiral. As Amazon moves further into healthcare it might find it easy to attract nurses. In the UK it is already one of the top 10 private sector employers.

There are hints that consumers are rebelling against prices. The volume of goods bought online in the UK has continued to decline since July as has the volume of items bought in UK food stores. November’s online price discounting failed to tempt shoppers.

That classic BBC sitcom ‘The Good Life’ set in Surbiton was perhaps the epitome of Middle England. Purely in the interests of research therefore, your writer popped into Surbiton’s branch of Waitrose to take the temperature. Quite unusually, there was shelf upon shelf stacked high with savoury Christmas food items all marked down and well ahead of December 25, too. Have other retailers also overstocked?

If Waitrose shoppers are feeling the pinch, then consumer demand is surely slowing fast – remember this should squeeze company profit margins. If so, then UK inflation may yet fall faster than currently expected as company profit margins are squeezed, and the outlook for interest rates later in 2023 ought to become more benign. Of course, energy prices still remain a major threat for the UK and Europe.


The European Central Bank (ECB) increased its deposit interest rates from 1.5 per cent to two per cent, as expected. What markets didn’t expect was what its president, Christine Lagarde said: 

‘We judge that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive. . . .We decided to raise interest rates today, and expect to raise them significantly further, because inflation remains far too high and is projected to stay above our target for too long.’ 

Although not in the same league, this was the punchiest statement made by the head of the ECB since July 2012 when Mario Draghi promised to do ‘whatever it takes’ to save the euro. The immediate market reaction was to price in a peak of 3.3 per cent by September 2023. This was the most dramatic tightening of monetary policy since German reunification.  

Our view: In our November commentary we said Christine Lagarde’s view that eurozone interest rates were stimulatory could be translated as ‘the beatings will continue until morale improves’. This month she said it loud and she said it clear. Markets were rattled.

Less than two months ago (October 27) President Lagarde said: "We are very much and deliberately turning our back to forward guidance." From then on, she said, the ECB would be ‘data dependent’, ie reacting or not as it saw fit. And yet her statement above strongly tells us to expect additional rate rises. 

In the ECB press conference following the rate rise decision she further told us: ‘It is pretty much obvious that, on the basis of the data we have at the moment, 'significant rise at a steady pace' means that we should expect to raise interest rates at a 50-basis-point pace for a period of time. We have more ground to cover. We have longer to go, and we are in for a long game.’ This is what rattled markets. For example, Italy’s cost of borrowing over 10-years immediately shot up to 4.4 per cent. Ouch. Recall that during the pandemic Italy was able to borrow at under one per cent. 

Perhaps coincidentally, the EU recently told Italy it had not made progress on key fiscal reforms. The ECB just made that harder. But not just for Italy. All eurozone states will have to borrow more because of the energy crisis at a time when their economies are heading into recession and the central bank is pushing up interest rates. Central banks are supposed to cut interest rates to alleviate recessionary conditions.

Central bankers do on occasion say things they later regret. This may be one of them. A while back Lagarde said the ECB was not there to pay for Italian profligacy (to ‘close bond spreads’ in central banker jargon). That statement caused a massive spike in Italy’s borrowing costs and she then had to correct herself. 

We frequently remind readers that the ECB does not publish a voting record of its decisions. That’s because it is a highly politicised organisation. The deliberate obfuscation makes it harder for markets to parse bank pronouncements than for the US or UK. The latest rate rise is a case in point. 

It appears the ECB’s chief economist, Ireland’s Philip Lane, wanted a 0.5 per cent rise whereas a large proportion of EBC members, many with German accents, wanted a 0.75 per cent and were prepared to block the vote. Four sources told Reuters that the impasse ended only when Lagarde offered to signal further 0.5 per cent rises together with a tough message on inflation during her press conference. This wouldn’t be the first time northern European politician/bankers have thrown their weight around and its serves as a reminder that Teutonic tectonic tensions lie beneath the surface of the faceless currency.

Global central banks are not infallible; they do make mistakes. Rather grandly, these are called policy errors. This time last year, inflation was only a minor problem for the ECB. And now, like the US and UK, it is playing catch-up like crazy. Central banks have exacerbated the inflation crisis and currently look set to aggravate the economic slowdown in 2023. It looks like we can expect a bumpy year ahead.


In our November review, we said the Chinese authorities risked either losing control of public patience or control of the virus. They have opted for the latter in a breath-taking winter U-turn. Quarantine and travel restrictions have been relaxed, testing booths dismantled and tracking apps abandoned. Most insidiously, the obligation to report asymptomatic cases has been scrapped. This means that nobody will ever know the true extent of the infection or the speed at which it rips through the population. Expect deaths to be attributed to other causes as we saw so regrettably in many care homes here two years ago. So far, the biggest surge is in Beijing where almost half of the 22 million population is estimated to be infected. 

Our view: The authorities appear to be gambling that the omicron variant is relatively mild. We hope they are right. The population will not be happy if they see hospitals, morgues and crematoria overwhelmed. 

The omicron variant BF.7 in Beijing is highly infectious with an R0 of 10-18 (one infected person will transmit the virus to 10-18 other people). This estimate matches report by Beijing authorities who said fever clinics in the city received 16 times more patients on Sunday, December 11 than the week before.

On the plus side it ought to go through a population fairly quickly. Right now, factories are closing and supply chains are freezing as truck and delivery drivers fall ill. We would not be surprised to see severe disruptions lasting well into February.

Since the state is not measuring infections, the Chinese population (and ourselves) must rely of anecdotal evidence. The problem here is that fear will dominate. Fear of Covid, fear of having no treatments available and fear that the authorities might yet reimpose strict lockdown measures. Fearful people are more inclined to save than to spend. 

With the annual New Year travel migrations happening soon, there is the potential for three waves of infection. First within cities, second when an estimated 290 million migrant workers visit their hometowns for the New Year and then third, when they return to their coastal cities of work. The hope is that the omicron variant, though more infectious, is comparatively less harmful. 

We continue to think that the second largest economy in the world could be in for a volatile six months with policy errors more than likely. We simply don’t know what effects these waves could have on the Chinese economy. Set against this, it may be that by the second half of 2023, China and her economy recover, demand for oil soars and inflation in the West becomes a bigger problem than anticipated. 

And finally: Bob Dylan has been offered a walk on part in a karaoke scene in Coronation Street after saying he had enjoyed binge watching the Northern soap opera.

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