The RSM US Financial Conditions Index inched down to 0.6 standard deviations below neutral from 0.4 previously as policymakers, investors and firm managers prepare for a period of higher interest rates and persistent inflation.
Markets are moving to price in a hard landing around a synchronized tightening of monetary policy by global central banks.
The Federal Reserve has imposed a ferocious clampdown on borrowing and lending, raising its overnight rate by 450 basis points over the past year. And it has made clear its intentions for further hikes to subdue inflation and wage increases.
Following Federal Reserve Chairman Jerome Powell’s remarks on Tuesday, it is clear that there is a risk that the central bank may hike rates by 50 basis points at its next meeting in two weeks.
Given the chance of another strong jobs report on Friday and with inflation remaining elevated in the service sector, financial conditions are likely to tighten in the United States through midyear with a risk of a 6% policy peak.
The result is a growing risk of an enhanced period of global central bank tightening through at least the middle of the year.
The Bank of England raised its policy rate by 50 basis points at its meeting on Feb. 2, with expectations of three more 25 basis-point hikes by the end of the year.
It’s the same with the European Central Bank, which will almost certainly raise its policy rate by 50 basis points at its next meeting, with expectations of six more rate hikes as it plays catch-up.
At this point, such an aggressive stance around the world should not be surprising.
The share of economies that have suffered through high inflation over the past year is rising toward levels last seen in the 1980s, according to an analysis by the IMF.
Despite risk-management efforts by monetary authorities, market opinion until recently was that the hard-line stance of central banks represented an overreaction to risks to the outlook as inflation abated.
The result has been significantly lower credit spreads in money markets than would otherwise be expected given the risks that central banks will need to implement more restrictive policies to create labor slack that cools inflation.
The move of the two-year Treasury yield above 5% and the stalling out of the 10-year yield just below 4% have created an inverted yield curve not observed since 1981.
While there are several yield curves that can help ascertain the direction of economic activity—the three-month, two-year forward is our preferred metric—they are all now pointing toward slower growth as short-term rates price in a more restrictive Federal Reserve and a probable hard landing for the economy.