Markets to Watch This Week: Fed, BoE and ECB to Deliver 50bp Hikes

We standardise WoW price changes across different markets to allow for cross-market comparisons.

Market Moves

Last week was quiet as markets prepared for three central bank policy meetings: the Federal Reserve (Fed), Bank of England (BoE), and the European Central Bank (ECB). That does not mean, however, that the week lacked important developments.

China further eased zero-Covid restrictions. It made 10 further adjustments on 7 December:

1. Confine risk areas to buildings and specific floors.
2. Require PCR tests only in high-risk areas.
3. Allow infected to isolate at home.
4. End high-risk lockdowns following five consecutive cases without a case – known as ‘quick sealing and quick release’.
5. Ensure all pharmacies remain open.
6. Vaccinate more senior citizens including adopting ‘incentive measures’.
7. Grant family physicians and neighbourhood clinics authority as ‘gatekeepers of health’.
8. Not restrict personal mobility in low-risk locations.
9. Prohibit the blocking of access to medical treatment.
10. Improve prevention and control measures in education.

We prefer expressing a rebound in China’s domestic economy via long Hang Seng. Chinese stocks have cheap valuations, and positions are still underweight. CNY will also benefit if Chinese stocks rise but still face headwinds: a declining trade balance when the domestic economy rebounds (i.e., higher imports) and potentially by a wider services deficit (as more Chinese people travel).

Brent crude oil fell $12/bbl over the past week (Charts 1 and 3). The sharp decline in spot prices comes as the markets digest G7 sanctions on Russian oil, upcoming IEA and OPEC demand/supply estimates andthe Fed’s continued battle with inflation.

And at Macro Hive, we published the final of our 10 Grey Swans for 2023. You can watch Bilal and Richard Jones discuss them here. Lastly, the future has arrived. We tried out ChatGPT. Here are 11 things it can(not) do.

The Week Ahead

Markets will concentrate on the Fed (Wednesday), BoE and the ECB (Thursday).

The FOMC Meeting (Weds)

Dominique expects a 50bp hike of the federal funds rate (FFR) to 4.25-4.50%.This meeting will also produce a Summary of Economic Projections (SEP), so we will get a new terminal FFR. Public FOMC members’ chatter suggests the doves were content with 5.00-5.25% as the new range, up 50bp from the September SEP.

Following the non-farm payroll and November Atlanta Fed median wage release, the doves will probably raise their estimates another 25bp. The hawks, however, are unlikely to have been surprised by either. Accounting for voter influence, the FOMC skews dovish. Therefore, Dominique expects the median terminal FFR to be about 5.20-5.50%.

The market is under-pricing the FFR trajectory. In addition to under-pricing the terminal FFR at a tad below 5% in May 2023, markets have completely unrealistic expectations of Fed rate cuts. The last time core PCE was at 5% was in 1983, it took more than 10 years for inflation to fall to 2% and for the FFR to fall from 9% to 5.75%. It may not take 10 years this time, but it sure will not take six months either.

The BoE Meeting (Thurs)

Henry expects the BoE to fall back to a 50bp hike. The arguments for a majority backing more than that seem relatively weak given the trajectory for the labour market and inflation expectations. However, the arguments for pausing right now also seem weaker after the Autumn Statement. The tempering of the dovish tone by the likes of external monetary policy committee (MPC) member Swati Dhingra (rates peaking below 4.5%) sits in line with this.

There will likely be a significant divergence in MPC voting, with external MPC member Silvana Tenreyro likely to lean towards a pause. A rally around 50bp by the hawks would be a dovish signal that the period of front-loading is ending.

The ECB Meeting (Thurs)

Henry expects a 50bp ECB hike. However, 75bp remains a tail risk. There is growing consensus among the major figures (Christine Lagarde, Philip Lane and Isabel Schnabel in particular) that loose fiscal policy is raising the risk of medium-term inflation. The ECB now estimates just 15% of fiscal measures are ‘temporary, targeted and tailored’. Meanwhile, policymakers seem reluctant to outright deny the prospects of 75bp.

Moreover, ECB forecasts for medium-term inflation would support this hawkishness. The risk to credibility of assuming another near-term peak in inflation, the lack of progress in softening underlying inflation, and the recent rise in European gas prices all point towards the ECB erring on the hawkish side for its inflation forecasts. This would likely mean a further delay in the estimate for peak inflation, and a further rise in end-2024.

As a result, Henry believes there has been little to support a decline in terminal rate away from 3%. And on ECB quantitative tightening (QT), Henry thinks there should be room for a relatively aggressive initial path, but with allowances for less to be rolled off and flexibility to see off fragmentation.

Watch Andrew and Dominique discuss the past week, notably Chair Jerome Powell’s credibility and Fed data points, and the week ahead. They also discuss how quickly inflation should be falling.

Chart 1: China Rebounding, Oil Plummeted

Chart 2: China Equities Undervalued and Rallying

Chart 3: Brent Crude Plummeted

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer, a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)