It was a busy week for central bank hikes (Fed +75bp, BoE +50bp, Norges Bank +50bp, Riksbank +100bp), but it was the market moves on the back of the UK Chancellor’s ‘fiscal event’ that stole the show. The announcement itself was largely telegraphed, with a large rise in immediate spending to cover an energy price cap freeze, and more long-standing deficits from tax cuts.
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It was a busy week for central bank hikes (Fed +75bp, BoE +50bp, Norges Bank +50bp, Riksbank +100bp), but it was the market moves on the back of the UK Chancellor’s ‘fiscal event’ that stole the show. The announcement itself was largely telegraphed, with a large rise in immediate spending to cover an energy price cap freeze, and more long-standing deficits from tax cuts. However, the debt funding for the plan, and the concentration of gilt issuance in the short-end (<7Y) was a surprise. The market reacted badly, with GBP and UK bonds selling off sharply. Pricing for a BoE hike jumped to 150bp by the end of November’s meeting, with a 6% terminal rate now priced.
Elsewhere, it was a hawkish Fed meeting, which saw the dot-plot predicting 125bp of hikes into the year-end, exceeding even Dom’s above-market expectation of 100bp. Risk assets sold off on the back of this, while USD found a strong bid. Broad USD is now within 5% of the peak strength it saw in 2001.
The Week Ahead
After a busy week for central banks last week, this week turns to speaker comments.
In the US, Powell, Brainard, Williams, Collins, Bostic, Evans, Mester, Daly, and Bullard are all on the wires. It will be Collins’ first public speech as president of the Boston Fed and Dom expects her to be more on the dovish side. Dom has increased her conviction for terminal FFR of 8%, but is now thinking we get there by the Fed reacting to strong actual inflation data and hiking c.75bp per meeting, which would bring us to close 8% by mid-2023. Previously, she expected the Fed would slow hiking to assess the impact, and eventually capitulate at the March 2023 to announce a much higher terminal rate.
In Europe, central banks are also in focus. Following the fiscal event and the BoE last week, we will hear from a range of MPC speakers. There is a risk given the market moves that the BoE sets out a statement / announces an emergency meeting. The market seems highly keen to hear the BoE support GBP. Action there would likely need to come via a rate hike (the BoE does sit on large FX holdings). Such a move would be a significant shift from previous MPC guidance and may make matters worse if it considered insufficient. More likely, given the heavy spate of speakers, is that for now they supply GBP supportive statements. That may see near-term GBP weakness resume, but we note that the UK fundamentals actually look relatively strong vs other economies, so would caution against extrapolating GBP weakness too far.
With the recent EGB selling, Italian 10Y yields are now pushing towards 4.5%. We are now in territory that the market may consider unsustainable, which could drive further weakness. Exacerbating factors to this are: the heavy spate of Italian bond supply needed into the YE, and the very tight deadline for submitting a draft budget to the EU (15 October). There are a lot of ECB speakers on the agenda, but thus far they have stuck to the line of fiscal prudence, rather than directly pushed back on spread widening. We are watching tentatively to see whether they may look to cap the widening.
For further analysis, watch Andrew and Dominique discuss the Fed hiking to 8%.
Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.
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 or 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.)
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