Shane O'Neill, Head of Interest Rate Trading
A busy month in interest rate markets, with all three major central banks holding meetings. Adding to the volatility were a number of data points suggesting the inflation battle, which had fallen out of focus during the mini-bank wobble, was far from over.
In the US, markets were kept on their toes by the lingering debt ceiling issue – though in the past these concerns have always amounted to a non-issue, growing polarisation in the US meant the risks of no-deal and default were more pronounced this time around. Ultimately, it looks as if a deal has been reached and the issue will fade away, but it created a month of volatility and, somewhat counterintuitively, supported the dollar as investors looked for safe havens.
As the concerns around the regional banking system began to fade, central banks were once again able to focus on the underlying issues in the economy. The first meeting of the month came from the Fed – they hiked, as expected, by 25bps taking the upper bound to 5.25%. The hike was accompanied by a dovish statement and press conference – the line: the committee “anticipates that some additional policy firming may be appropriate,” was omitted and chair Powell hinted toward a pause in the hiking cycle. After 500bps of tightening and continuing QT, financial conditions have tightened significantly, and this takes time to feed through to the real economy – a pause could easily be justified.
Making matters more complicated for the Fed is the continued data beats on inflation and employment. Core PCE, the Fed’s favoured measure of inflation, ticked higher in the last month and has been stuck over the last few months at ~4.8% - considerably above the 2% target. The labour market is showing similar stickiness – job openings climbed to over 10mio, reaching 3-month highs, and non-farm payroll figures continue to outperform. Whilst this dynamic of high inflation and strong labour markets continue – the Fed’s ability to remain passive on rates will become increasingly difficult.
The BoE meeting struck an entirely different tone, Gov. Bailey was at pains to reiterate the possibility of further rate hikes to curb inflation as the MPC hiked rates to 4.5%. This warning preceded worrying inflation data which saw core inflation in the UK rise to 6.8% from 6.2% previously. This data point forced traders to reprice expectations for UK rates and the peak is now expected to come in at close to 5.5%, and to remain above 5% well into Q4 2024.
The ECB were similarly hawkish, with Lagarde warning that inflation risks remain significant and that further hikes would be necessary to get the job done.. Where inflation data continues to be cause for concern in the UK and US the most recent data out of Europe surprised to the downside, though core numbers remain high (5.3%), seeing them come in under expectations will be a relief to ECB members.
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