The United States
Fed to make monetary policy announcement
Monetary policy will again be in the spotlight this week, with the US Federal Reserve scheduled to make a key interest rate announcement this evening (Wednesday, June 15) Swedish time. Just like most analysts, we expect a rate hike of 50 basis points to the 1.25-1.50% range, although there is now speculation that the central bank may instead raise the federal funds rate by a full 75 bps.
The Nordic countries
Swedish inflation climbed to 7.2% in May
The CPIF inflation rate (CPI at fixed interest rates) reached 7.2% year-on-year in May, according to fresh figures from Statistics Sweden. Month-on-month CPIF was 1.0%, largely influenced by rising food prices – with the largest increases for meat, eggs and dairy products, but the increase was dampened by lower diesel prices in May. The overall CPIF figure was marginally above SEB’s forecast of 7.1%.
Housing price expectations plunged in June
The SEB Housing Price Indicator shows that the share of Swedish households that expect rising home prices in the coming year is 31%, a decline of 11 percentage points from May. Meanwhile 47% of households expect falling home prices, up 23 points from last month.
Our market view
During the past year, the interest rate and bond yield situation has changed dramatically. Inflation began climbing in 2021. This past winter it became clear that this upturn would be bigger and last longer than most forecasters had predicted. Early in 2022 the inflation picture worsened further, with continued high worldwide demand but also continued supply side problems. Already-overextended global value chains have been further strained by widespread pandemic-related lockdowns in China. In addition, the tragic Ukraine war has driven up commodity prices and contributed to global supply disruptions.
Like most observers, we expect inflation to peak this year – very soon in the US and during the coming months in the euro zone and Sweden. But the downturn will be relatively prolonged. Inflation will exceed central bank targets at least during 2023.
There is no doubt that central banks will raise their key interest rates − some, including the US Federal Reserve, have already begun this process – and that they will end stimulative bond purchases. In some cases they will even begin selling bonds, again led by the US Federal Reserve. It remains to be seen how far central banks will hike their key rates. Their aim is to bring down inflation and cool off economies, not to trigger a deep downturn.
So the impact of the rate hikes on inflation will be crucial in determining their size. Tightening monetary policy just enough to slow down the economy without falling into recession has historically proved to be a difficult balancing act, boosting the risk of recession.
We expect the Fed to hike its key rate to 3.5% next year and Sweden’s Riksbank to raise the repo rate to 1.75%. Higher key rates and inflation have an impact on long-term bond yields, which have already skyrocketed. Reduced central bank bond purchases will also contribute to higher yields and volatility.
In our main scenario − a soft landing in the economy and central bank rate hikes helping bring down inflation towards target − we expect long-term yields to level out to about the same as short-term ones next year − around 3.5% in the US and just below 2% in Sweden. This would imply yield upturns of just over 0.5 percentage points during 2023.
All else being equal, rising bond yields are obviously not good for stock market performance, as we can see in this year's falling share prices. Equities are also being affected by the uncertainty surrounding the economy and thus the earnings potential of companies. On the other hand, due to stock market declines, both share valuations and investors’ risk appetite have of course fallen. This provides some hope, in any case if inflation falls without much further damage to economic growth and earnings.
Bond investments also took a beating early this year, with rising yields leading to price downturns. But the good news here is that yields are now starting to reach levels where fixed income investments may once again be an attractive alternative, after many years of almost non-existent yields and low potential returns.
We are still hesitant about investing in government bonds, whose rising yields may eat up much of potential returns. For corporate bonds, however, the situation is a little different. The credit spread − the extra rate companies have to pay for their borrowing − has been pulled apart by market turbulence, which means that running yields are starting to reach appetising levels.
Given economic uncertainty, new yield upturns or widening credit spreads cannot be ruled out. This would result in further price declines, but would also increase the probability that a buying opportunity will arise.