Going up slower is not the same as going down

Last week I told you how there was enthusiasm in the financial markets regarding inflation expectations for next year. This Tuesday we saw an additional boost in this regard with the favorable inflation data for November.

However, the Federal Reserve (Fed) yesterday pricked enthusiasm by raising the benchmark interest rate by half a point and maintaining a tightening stance that does not appear to be ending anytime soon.

As I was saying, inflation in the United States decreased both in the general part and in the subjacent part. In the first case, the annual rate went from 7.7% to 7.1%. In the second, from 6.3% to 6.0%. Within the non-core index, the falls in energy prices stood out, mainly gasoline. Food prices continued to rise.

As for the non-core index (which excludes energy and food), used car prices fell for the fifth consecutive month due to lower demand for these goods and the transportation component finally came under less pressure; what has not moderated yet are the rents in the housing price component.

The markets showed a very positive reaction to this data. Calling attention was the push in long-term rates to levels below 3.5% and a jump in positive returns on the stock markets.

Two ideas supported this optimism: One, the reinforcement of the expectation of lower increases in the reference interest rate by the central bank; the second, the idea that the monetary tightening cycle is close to its end and the possibility of seeing interest rate declines as early as the second half of 2023, due to the downward trajectory of inflation.

Yesterday, members of the Fed’s Open Market Committee (CMA) took it upon themselves to consolidate a less than enthusiastic expectation. The official communiqué argues that subsequent increases in the reference rate would be appropriate to ensure a stance that is restrictive enough for inflation to return to its target of 2 percent.

Along with the statement, the Fed published its traditional “dot chart” where the official members of the CMA reflect their considerations at the individual level.

The median estimate for the federal funds rate in 2023 is located at a level between 5.00% and 5.25%, above the previous estimate published in September of 4.5% – 4.75 percent. This implies at least a level 75 base points higher than the current one.

More importantly, most estimates project a decline in the rate to a level of 4.0% – 4.75% in 2024, higher than the level below 4% projected in September.

Inflation has declined visibly in October and November, but it is clear that the Fed is still some way from finishing its control job.

In a press conference, President Powell was emphatic on the matter. He mentioned that the effects of his restriction are yet to be seen, referring to the expectation of a decrease in employment in particular. He spoke of the fact that a substantially higher level of evidence is needed to consider that inflation is on a downward trajectory and that with that he does not see the CMA in a position to consider downward movements in rates.

After these assertions we should see the markets temper their enthusiasm again. Possibly we will see some correction in the stock markets and a return of long-term rates.

This is not to say that the course towards 2023 is worrisome, on the contrary, inflation will drop and it is very likely that the central banks will stop raising their rates. It is simply not time to price in a second phase where there will be declines, unless the size of the possible recession is large and the rate of decline in inflation is strong. Uncertainty remains high in this area.

In Mexico, today the central bank must determine an increase in the reference rate for one day of 50 basis points. Inflation in Mexico has not produced such good results; for example, core inflation is above headline inflation, both at levels above 8 percent. Nor is there a context for the Bank of Mexico to moderate its discourse or change its position, call it detaching itself from the movements made by the Fed or arguing that it has already risen too much simply because it started before the US central bank.

In summary, inflation has started with the decline that many of us had been anticipating since the summer and the central banks are less aggressive for this reason; but the end of the restrictive cycle has not yet arrived (although it seems closer) and for this reason, the permanence of rates at high levels for a good part of next year sounds like the most reasonable expectation.

*Rodolfo Campuzano Meza is CEO of Invex Operadora de Sociedades de Inversión.

perspectivas@invex.com

Twitter: @invexbanco