Shane O'Neill, Head of Interest Rate Trading
We had central bank meetings in the US, UK and Europe this month and the net effect was yet more volatility and, again, higher rates. The fight against inflation is proving increasingly challenging and as central bankers square up to the challenge, the likelihood of a soft landing becomes ever more remote.
The first bank to come to market was the ECB – they confirmed their intention to hike in July and again in September. Though they alluded to the moves being 25 bps, they kept the door open on 50bps moves, stating that “a larger increment will be appropriate” if the inflation outlook “persists or deteriorates.” The other detail markets were watching closely was this mysterious tool to fight fragmentation, Italian/German 10y spreads had moved over 100bps this year, almost reaching its pandemic peak. Light on details about the mechanism of controlling these peripheral spreads, the market tested the bank’s limits. So much so that in the days following the official meeting, they called an “emergency meeting” – though concrete solutions were again missing, their emphasis on flexibility of PEPP reinvestments seemed to do the trick and peripheral spreads collapsed. This story is far from over and it remains to be seen whether the ECB can hike rates, fight inflation and, essentially, buy more bonds in the periphery – if that is even legally viable for them. If inflation is the bloc’s main risk, fragmentation is close behind.
The Fed followed and despite Powell’s insistence in a recent meeting that moves of 75bps were not an option, they hiked by 75bps. His reasoning for the surprise move was a worsening of CPI data during Fed policy makers black out period, when they cannot communicate with the market as we approach the meeting. The inflation print was a worrying sign for the market – US inflation was expected to have peaked, but it printed yet another multi-decade high of 8.6%. Though Powell asserted that he didn’t expect moves of this magnitude to be “common”, it hasn’t stopped the market from pricing in close to two more 75bps hikes in the next two meeting, and a fed funds rate of 3.5% by year end.
Going into the BoE meeting the market was split 50/50 on whether we’d see a 25 or 50bps hike – the MPC went with 25bps with 3 dissenting voters calling for 50bps. Despite being on the lower end, traders pushed expectations of future hikes higher immediately. Though initially a little illogical, and perhaps down to terrible market liquidity, the move was vindicated by this week’s CPI print – another 40 year high of 9.1%, with expectations of peaks over 11%. MPC members speaking after the meeting have made their (hawkish) feelings clear – fight inflation even at the expense of growth.
As we move into the second half of the year, keeping an eye on recessionary indicators will become a hot topic – whether that be widening corporate spreads, further falls in equities, a turn in eco data, or a flattening of the yield curve. The months ahead look set to be rocky and volatility in rates markets is far from over.
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