Rate expectations continue to build
View from the Trading Desk
Despite some interesting results from the first round of the French election—where Emmanuel Macron gained a lead over far-right candidate Marine Le Pen—and Ukrainian President Volodymyr Zelensky consolidating support before another offensive in Eastern Ukraine, there isn’t much happening in markets this week. So instead, we’re focusing on the debate over central bank rate expectations, where more market pundits are coming out with dire predictions for the current path of policy tightening.
The market has already priced in most of the 50 basis-point hike expected at the Federal Reserve’s next meeting in May, alongside the anticipated aggressive tapering of its portfolio holdings at a maximum monthly pace of $60 billion in Treasuries and $35 billion in mortgage-backed securities per month. We’ve long argued that a reduction in the stock of its asset holding was beneficial to combat asset price inflation, but the simultaneous steep climb in rates—Bloomberg forecasts suggest the policy rate will climb by 2% by year-end—has some Fed-watchers nervous that the bracing of policy measures could tip the US into recession.
The European Central Bank is also signalling that it intends to normalise policy over the course of this year and will hold its next press conference on Thursday. Bloomberg estimates that the ECB’s policy rate will be back in positive territory by the end of the year—currently, the deposit rate is -0.5%. The Bank of England sits somewhere in between, with 1.5% in rate hikes anticipated by year-end.
Bottom line: The fear from market pundits isn’t unfounded. The risk is not a single rate hike, but coordinated tightening by all the major central banks, as well as a faster pace of asset sales—having a similar impact as rate hikes—which can threaten stability. It seems asset portfolio sales are a strong policy choice that should dispel some of the quantitative easing’s inflationary effects while mildly tightening interest rates. However, the growing pace of policy rate increases is more worrying. Most have argued that the Fed was late to the game and is playing catch up, and that might be right, but the pace of policy changes matters. Waking one morning and realising that you have forgotten to take medicine the previous day doesn’t mean you should take a double dose today.
The week ahead
Sterling faced continued pressure from US Dollar strength last week, with Cable falling another 50 basis points to a fresh year-to-date low of 1.2984. The downtrend in the pair, which started in June 2021, looks likely to continue in the coming months as UK households start to feel the pressure of rising expenses. Gross Domestic Product data for February came in weaker than expected, with the economy expanding just 0.1% as manufacturing and construction output fell. Markets have priced in a further 125 basis points of interest rate hikes for the rest of the year, but the Bank of England policymakers seem cautious to stick to a schedule as the growth outlook appears more uncertain.
- The UK’s GDP m/m for February came in at 0.1% this morning—much lower than the 0.8% reading in January.
- The Unemployment Rate for February will be released tomorrow, with analysts expecting a 3.8% print.
- UK Consumer Price Index and Core CPI y/y data for March is due out on Wednesday. Current projections are for readings of 6.7% and 5.3%, respectively.
- UK markets will be closed at the end of the week in observance of Good Friday.
The Euro recovered this morning, rising back above the 1.09 handle against the US Dollar as markets turn their focus to the European Central Bank monetary policy decision this Thursday. ECB officials appear to be more aligned on the need to raise interest rates heading into the next meeting, and the markets agree, with traders expecting an end to nine years of negative interest rates by December. In the French elections, Emmanuel Macron won the first round with 27.60% of the vote while Marine Le Pen secured 23.41%. The final round of the election will take place on the 24th of April. Macron is marginally ahead in the current opinion polls with 51.00%.
- German final CPI m/m is expected to remain unchanged at 2.5% for March.
- The ZEW Economic Sentiment surveys will be released tomorrow for the Eurozone and Germany. Analysts expect -46.5 and -48.4 readings, respectively.
- Italian Industrial Production m/m for February is forecast to come in at 1.2% versus a -3.4% reading in January.
- The European Central Bank will meet this Thursday to publish its latest Monetary Policy Statement.
The US Dollar Index has had a muted start this week, which has been trading flat on the day. US stock market futures ticked lower at the start of this week, with Treasury yields climbing yet again as Federal Reserve monetary policy tightening continues to dominate sentiment. The Federal Reserve is now expected to deliver two 50 basis point rate hikes in its May and June meetings following hawkish comments from Lael Brainard last week. Economists are wary of this approach to catch up to runaway inflation, with many suggesting that such aggressive tightening in a period of uncertainty around growth could cause the US economy to fall into a recession.
- US CPI and Core CPI m/m releases for March will be published on Tuesday. Respective prints of 1.2% and 0.5% are forecast.
- Federal Open Market Committee member Lael Brainard is due to speak on Tuesday at 5:10PM.
- On Wednesday, US Producer Price Index and Core PPI m/m for March will be published, with analysts expecting 1.1% and 0.5% readings, respectively.
- US Retail Sales and Core Retail Sales m/m are due for release on Thursday at 1:30PM—0.6% and 1.0% readings are indicated for March.
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