Though announced by central bankers last week, markets were still not aligned with the incoming interest rate hikes.
Minutes from the American Federal Reserve and the European Central Bank show that interest rates will keep rising for the rest of 2023. Though predictable, markets were still optimistic and planning on a few rate cuts by the end of the year.
Interest rates are "the cost of money". When raised, it costs more to borrow cash and the economy is fueled by less liquidity. This move is necessary to make currencies more valuable, therefore fighting inflation.
Inflation is, on the contrary, when money is too cheap. There’s too much liquidity in the economy and investors can borrow cash at a bargain.
When inflation is too high, like in the last two years, living costs skyrocket.
Since the end of the Covid pandemic, when two years of savings eventually hit the market all at once, inflation has been steadily high. At its peak, US inflation reached 9.2%.
Therefore, central banks from around the world were forced to raise interest rates, risking a recession in 2023.
But inflation has been decreasing more than expected, with the last US measure showing a decline to 4%. For this reason, the Fed decided to pause interest rates at its June meeting.
Yesterday’s Fed minutes showed that not everybody agreed with the strategy, though in the end it was a unanimous decision. Many analysts, including Fed Chairman Jerome Powell himself, see at least two more interest rate hikes in 2023.
European crisis
The European Union is facing a slightly different scenario, with the ECB never considering a pause in rate hikes even though, like in the United States, inflation is dropping more than expected.
But ECB President Christine Lagarde believes EU inflation is still "too high", sitting at 5.5%. European inflation is higher due to the recent energy crisis and the war in Ukraine.
Reading the ECB minutes, Bloomberg analysts figured the ECB would raise interest rates by another 0.5% in 2023, with the first rate cut coming in June 2024.
By then, the entire European Union will have fallen into crisis. At the moment, Germany and the Eurozone already face a technical recession.
European markets are realigning with the reality of the situation. The Frankfurt DAX on Thursday morning dropped by 2.32% from Tuesday’s highs. The Milan stock exchange fell by 1.82% during the same period of time.
A recession in Europe is inevitable. The question remains whether or not it is in the United States. Will Washington achieve a "soft landing"?
