Shane O'Neill, Head of Interest Rate Trading
Two central bank meetings in November and two very different tones. First we had the Fed come to market – as expected they hiked by 75bps for the fourth meeting in a row. The release, which came alongside the hike, was interpreted as dovish with the Fed acknowledging that the tightening of conditions takes time to feed through. Market participants read this as a pivot or setting up for an impending slowdown in hike pace, though this dovish sentiment was short lived.
Powell’s press conference, which followed shortly after, was overtly hawkish and there were three main takeaways: Looking at recent data, the market implied terminal rate is not high enough; rates may need to stay higher for longer if we are to deal with inflation; under-hiking is a greater risk in the eyes of the Fed than over-hiking. These developments took the terminal rate above 5.1% for the first time.
Following the Fed, we had the BoE and the tone couldn’t have been more different. The MPC did go ahead as expected and hike by 75bps in a split vote decision – with 1 member calling for a 50bps hike and 1 for a 25bps hike. Despite this being the biggest hike in decades and taking the base rate to a post-08 high, in the presser that followed, Bailey painted a very sorry picture. The MPC now expect the longest recession going back to the 1920s and the depth of the recession to be worse than previously projected – the fall in growth is projected to wipe out 3% from UK GDP, versus 2.1% in August.
This led to Bailey directly addressing market pricing, as Powell did, but in this instance Bailey remarked that the terminal rate would likely be lower than priced by the market. The interpretation here was that Bailey would take the base rate to 5% but would be very reluctant to pass this point – the knock-on effect of which could be a lower peak but rates elevated for a longer period to help deal with the inflation issue.
Which brings us to the second half of the month which was defined by inflation prints. Again, it was the US up first and CPI came in lower than expected (7.7% vs. 7.9%). This also marked the 4th consecutive fall in CPI. The market gained renewed confidence that the peak is behind us and allowed traders to once again re-instate the pivot trade and challenge Powell’s rhetoric. This saw terminal rate expectations tumble by 30bps from their recent highs.
Again, the picture in the UK was quite different – CPI figures came in higher than expected at 11.1%. Despite this, rate movements were very muted and the terminal rate hardly budged from 4.5%. Aided by the BoE rhetoric and compounded by large positioning in the market, we actually saw a slight decrease in rates following the print.
Over the last several months, rates have been a one way game but that is set to change – market dynamics are now considerably more nuanced and two-way risk is back on the table. Risk managers ought to consider this carefully when implementing rates hedging strategies going forward as we get used to a two way volatile rates market.
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