The sizzling rally in January may have gone too far and markets began to cool in February in response to signals that the economy remains too hot.
Lower recession risk
The narrative around recession continues to evolve. Despite heightened probability of recession, economies continue to show resilience and unexpected pockets of strength. The soft-landing/ hard-landing narrative has been usurped by the potential for a “no-landing” scenario, the word-of-the-month for economists in February, which points to continued but anemic economic growth, a low unemployment rate and moderating inflation.
Inflationary pressures re-ignited
Globally, inflation has been cooling since it peaked in early 2022 partly due to falling energy prices, partly due to prices of durable goods as the supply chain continued to heal. However, January’s inflation data surprised to the upside in the U.S., Germany, and Japan, with pick up in spending on goods and services, including motor vehicles, food services, and accommodation.
Peak rates moved higher
With tight labour markets and stubborn inflation, the Federal Reserve has, towards the end of the month, doubled down on their hawkish rhetoric and expressed the need to raise rates further. Bond markets sold off quickly, 10-year government yield rallied from a low of 3.39% in early February to end the month at 3.92%. The expectation for peak rate in the U.S. also moved much higher, from under 5% to over 5.5% in June 2023. The market no longer expects meaningful rate cuts by the Federal Reserve in 2023. Current expectations are for rates to remain above 5% through early in 2024.
