Can we count on a pivot by central banks or is it too soon?

It is now almost one year since the leading market equity indices reached all-time highs. Since then, the stock markets have been on a bit of a rollercoaster ride, which is still manifesting in dark red performance figures. This is being blamed on the distinct economic slowdown, for which there are obviously lots of reasons, and especially on the monetary policy, which has become more and more restrictive for a year now. Years of zero- and even negative-interest-rate policy have made a mockery of a valuation logic hinging on a market-based (positive) discount rate. The falls in prices we have seen can therefore easily be interpreted as an interest-driven correction of earlier price excesses. Since there is no historical precedent for such a sequence of interest-rate rises, they have resulted in a certain degree of volatility in capital markets as valuations have adjusted. This year, talk has centred on speculation over the path of tightening. Now that the U.S. central bank plans to slow the pace of interest-rate rises, some of this uncertainty has been dispelled.

The focus is now shifting onto the matter of the target rate and what will happen once it has been reached. For weeks the narrative of the pivot or rather guessing when rate cuts will begin has been making headlines and causing movements in prices as a result. What we can see in relation to this, however, is a discrepancy between the statements of various central bank officials and the pricing of the relevant futures. While the central bankers want to accomplish their objective of combatting inflation and certainly do not want to repeat the mistakes of the 1970s (overhasty interest rate cuts), the futures market is already pricing in these same interest rate cuts as early as the end of the year. The market is now embracing this prospect with corresponding rallies in risk assets. We question this development thus: if it is fanciful – coming from such a high level of inflation – to go straight back to the central bank’s target of 2%, what could prompt the interest-rate cuts that have been priced in? Economic growth that turns out much more negative than expected to date would, despite an estimated inflation rate of around 4%, at least be a valid reason for fresh interest rate cuts as early as 2023. However, this flies in the face of a bullish equity market, since, if a recession occurs, much more valuation adjustments will be required. There’s a saying for that: be careful what you wish for.