Charts of the Week (Sep 22, 2023)

US Treasury yields While the Federal Reserve’s decision to hold interest rates steady was widely expected, its “dot plot” nevertheless suggested that another hike remains probable by the end of the year. In addition to this fewer rate cuts than previously indicated have been pencilled in for next year. Unsurprisingly, this has rattled investors as 2-year yields climbed sharply in the aftermath of the Fed’s meeting. That the spread between 10-year and 2-year yields widened again additionally suggests that US recession odds have been marked higher by investors as well (chart 1).

Energy prices One key reason why central banks may be a little more alarmed about the inflation outlook at present concerns the oil price. The consumer price of energy has started climbing again in most major economies thanks to the spike higher in the oil price in recent weeks (see chart 2). That incoming inflation data have begun to post positive surprises relative to consensus forecasts again can in large part be traced to these energy price issues.

UK financial markets This week’s decision by the BoE to leave policy rates unchanged echoed the Fed’s decision but there has arguably been more willingness from UK policymakers to admit that their tightening cycle is at, or near, its completion. Coupled with more friendly UK inflation data this week this is why 2-year gilt yields in the UK have, on the whole, been falling of late and why sterling has been depreciating as well. The path that financial markets in the UK have taken more generally over recent months stands in vivid contrast to last year and the immediate aftermath of PM Truss’s mini budget. That generated a sharp sell-off in UK financial markets as the risk premium that was attached to UK assets was lifted sharply thanks, in turn, to the highly unorthodox –and very loose - fiscal policy that was announced at that time.

Japan’s JGB yields Ahead of this week’s BoJ decision, JGB yields have been advancing and are now closer to their new implied upper limit of 1%. The upward pressures on yields of late are probably in anticipation of additional Yield Curve Control policy (YCC) tweaks, and on speculation of subsequent monetary policy normalization by the central bank. While no major tweaks are expected this week, subsequent shifts could be significant given the hefty role that Japan’s savings an investment flows play in global financial market reverberations.

FX reserves in emerging economies Our newly calculated aggregations for foreign exchange reserves in emerging economies (EM) suggest that many of those economies have been confronting bigger financing pressures. As chart 5 below indicates, FX reserves in high-income and low-income EM economies declined sharply through the course of 2022 as a deteriorating outlook combined with capital outflows, rising risk premia and US dollar appreciation.

India’s capital flows One noteworthy exception to that aggregate rule of thumb, however, concerns India. Foreign institutional and portfolio investors have poured around a net $19 billion into India’s financial markets so far this year, lending support to India’s FX reserves.