JP’s Journal: Do away with VAR

Federal Reserve (Fed) watching was the main focus of markets last week. As expected, there was no interest rate change.

The thrust was that it was not appropriate for the Fed to lower rates until they are more confident about inflation trends, that current data did not provide this confidence and that it will probably take longer than expected to get it.

There has been some speculation that the next move in US rated could be up – not down. According to Chairman Powell this is “unlikely”, referencing that current policy was already tight. Overall, the theme was that whilst wage growth was important, it was the overall inflation trend that was the main consideration in the setting of interest rates. Powell’s said that he wanted workers to earn more, as long as inflation did not eat up their gains. The message was that a moderating economy would help deal with supply-side issues, which could mean greater wage stability in the future. He re-iterated the view that interest rates were the main monetary policy instrument, and that slowing down the balance sheet run-off was just a way to reach their desired level in a smooth and orderly manner that avoids market disruption. In further musings Powell rejected the idea that the US economy was facing stagflation – the combination of low growth and high inflation. He remarked that he had lived through that period in the 1970s and that the current situation is different.

Bond markets took comfort from last Friday’s employment data which was softer than forecast. Non-farm payrolls rose by a less than expected 175,000. Importantly, there was a weaker than forecast average hourly earnings figure with the unemployment rate rising to 3.9%. Overall, the releases added to the recent pattern of softer US activity, in contrast to the above-target inflation data. Yields on 10-year US treasuries fell 15bps on the week, closing at 4.5%. Real yields declined by less, with implied inflation back below 2.5% at the 20-year point.UK bond yields followed the global trend as 10-year gilt rates fell towards 4.2%, a 10bps decline over the week.

The Bank of England faces its own interest rate decision this week. Again, there is no expectation of any change and the focus will be on the Monetary Policy Committee’s (MPC) updated economic projections. Since the last review, market pricing of Bank Rate has hardened, with 4.8% now factored in for end 2024, against 4.2% in February. More significantly, Bank Rate is shown at 4.3% by the end of 2025 compared with 3.4% last time. Offsetting this downward pressure on inflation has been the move up in the oil price, as tensions in the Middle East have escalated. On balance, I think it is likely that the MPC projections will show some weakening in both growth and inflation, although the mood music from MPC members is that the time is still not right to move rates down. There will be increased pressure for an early cut as the inflation data dips towards 2%; expect politicians and media to be clamouring for a cut over the next month or so.

Last week’s local and mayoral elections in the UK reinforced the message that the government is on course for a heavy defeat when the general election comes. What 14 years of Conversative-led government disguises is the profound shift in attitudes that has taken place. Confidence in market solutions has fallen, distrust of companies and their management has increased, regulation rather than competition is seen as a better way forward. A more forward-looking government would have seized the opportunity to put forward a more coherent philosophy but Brexit, Covid and infighting scuppered that chance. Expect more regulation in future from whichever party is in government, as this chimes with the public mood. A football regulator may be the first of many such roles. Now, can we do away with VAR?

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