The re-acceleration hypothesis

• The “dovish pivot” seems to be dead. Hawks should refrain from hasty moves though: even if the current data points to some re-acceleration in growth (at least in the US), history suggests that monetary tightening can hit the economy with a long lag.

At long last, markets have given up on the “dovish pivot”. Expectations of the Fed’s and the ECB’s terminal rates have been revised up and – more crucially – there is now less than a 25-bps cut priced in for the Fed in the second half of the year. This results from the combination of many indicators pointing to continued resilience of the real economy – or even re-acceleration –and hawkish noises from policymakers.

Still, as much as we considered the market had been impatient in pricing an early return to the good old times of friendly central banks, we think we should be quite prudent on growth prospects for 2023. Looking at past episodes of Fed tightening, it often took about a year for the labour market to exhibit tangible signs of deceleration. This puts the current robust dataflow in perspective.  There would be quite some damage for the Fed credibility if it chose to raise again the quantum of the hikes – as advocated by Bullard and Mester - just at the time the accumulated tightening finally makes its way to the real economy. This makes the approach by Barkin and Bowman quite reasonable: continue to hike, maybe for longer than expected, but by “cautious” increments of 25 bps. We will however watch the dataflow for February with some trepidation to make sure this “middle way” can win.

Of course, higher rates in the US have their usual transmission effects on Europe, even though macro conditions differ. Yet, the debate emerging at the ECB resembles the Fed’s, between those like Nagel and Schnabel who clearly want the continuation of the tightening at a fast clip, and those who argue for a more cautious, step by step approach, even if the direction of travel would still be up. But this is not for immediate consumption: the 50 bps move in March is in any case “in the bag” – it would take a proper catastrophe for the ECB’s “intention” not to be acted upon at the next meeting.