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Risk aversion being driven by tightening financial conditions

September 26, 2022
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Markets have been gripped by risk aversion since mid-August

Markets have been gripped by risk aversion since mid-August in response to hawkish Fed and global central bank guidance, elevated inflation, and a significant tightening in financial conditions.

Global interest rate forecasts continue to ratchet higher

Chart 1 shows the status of regional market interest rate forecasts for 2022 and 2023 as well as the respective central bank forecasts. It can be seen that except for Japan, all other regions have witnessed significant uplifts to interest rate curves over the last three months.

Chart 1: Regional consensus and central bank 2022 and 2023 interest rate forecasts

US interest rate forecasts have risen 100bp in the last month

Both the Fed dot plots and market interest forecasts have risen by 100 basis points. While the Fed forecasts point to a continued gradual increase in rates, peaking at 4.6% by the end of 2023, the market is predicting a gradual decline in rates over the course of the second half of next year.

Chart 2: US market consensus and Fed dot plot interest curves

US financial conditions are facing a perfect storm

Our Financial Conditions Indicator (FCI) is designed to reflect the impact on market risk appetite through the combined impact of related financial components. Since mid-August, the US FCI has increased and is in restrictive territory (a key driver of risk aversion). Some of the key elements pushing the FCI higher have been the rise in the USD (REER), interest rate forecasts, government and corporate bond yields and a contraction in real M2 money supply growth.

Chart 3: US financial conditions being driven higher on many fronts

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Writer

Philip Lawlor

Managing Director,  Market Research (Benchmarks)

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