Central Banks Navigate Rate Hikes and Market Expectations

Rates Spark: No pushback

Central banks continue to signal that their work is not done. The Bank of England is set to hike rates today, but more importantly, it is unlikely to push back against aggressive market pricing given its own uncertainty about near-term inflation. These circumstances add to the persistence of the curve's flattening bias, even around record inversions.

 

No change in message means no change in curve flattening bias for now

The spillover into other markets was limited in the end, but the higher-than-anticipated UK inflation data yesterday is a reminder of what drives the current hawkish stance of central banks. The focus on current (core) inflation to determine policy success will also mean that the flattening bias for yield curves will not pass quickly. Just as EUR and Sterling curves have moved to record inversions, a similar test of previous lows looks imminent in the US as well. Market circumstances such as the still punitive carry on steepening positions and declining liquidity going into summer only add to the persistence of the bias.

 

Fed Chair Jerome Powell reiterated the Fed’s “strong” commitment to bring inflation back to the 2% target, even though the prepared remarks of his testimony to the House broadly stuck to the script of last week’s FOMC meeting.

 

Policy rates were held to give time to assess the impact of past policy tightening while "nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year." Recall that the Fed's dot plots had been adjusted to see two more rate hikes this year. At the same time, with the messaging not going beyond what was said earlier, market pricing of the near-term Fed path was little changed - one hike is close to being fully discounted. If anything, there was a tendency to further price out cuts from the peak policy rate.

 

The BoE is unlikely to push back against market pricing

The Bank of England will make its decision today against a backdrop of inflation data continuing to surprise on the upside. The consensus is unanimously looking for a 25bp rate hike today, though likely most replies came ahead of yesterday’s data and some might now at least highlight growing risks of a 50bp move today. And indeed, the BoE itself might see one or two of its members voting for a larger move today. Our economist thinks the bar for a 50bp hike remains high, but a 25bp hike today and another one in August now look like a given.