Assessing Rate Expectations: Fed Hike Probabilities, ECB Alignment, Supply Impact, and Market Prepositioning
Aa
Share
For the Fed, the market is currently pricing a less than 30% chance for a hike on Wednesday next week, but it is seeing an 80% chance of a 25bp hike in July. Our house view is that the Fed is already at its peak policy rate, though with the caveat that a higher CPI reading could still eke out a hike next week. In any case, the Fed is likely to leave the door open to more, and in a hawkish no-hike scenario this could be reflected in the dot plots, the FOMC members’ projections of the Fed funds rate
In EUR money markets the pricing of the policy path looks pretty much aligned with the ECB’s own communication. A hike is a done deal for next Thursday and followed by at least one more in the following two meetings in July and September. This is largely in line with our economists’ prediction which sees two consecutive hikes as the base case.
To evaluate central banks’ effective policy stances one can also revert to OIS real rates. At levels closer again to the top of recent ranges, these suggest relatively tight policy circumstances, especially judged against the backdrop of the more mixed macro signals of late. This should give policy makers some comfort with regards to the reception of their recent communication, where the “skip”-narrative, bolstered by the Bank of Canada’s example certainly has helped to curb a more pronounced pricing of cuts further down the line.
Supply can add a bearish tilt especially early in the week
The US treasury will issue US$40bn 3Y and US$32bn 10Y bonds on Monday followed by a US$18bn 30Y bond sale on Tuesday. The setup around the CPI release and ahead of the FOMC meeting may warrant extra price concessions from dealers to absorb the duration risk. At the least, this could inject some extra volatility into the market.
Primary market activity will also remain elevated on the eurozone sovereign side. While it was syndicated deals pushing issuance volume higher this week, next week’s scheduled auction supply could already push volumes closer to €40bn - we will see Italy, Germany, Finland, the Netherlands as well as France and Spain all being active with bond sales.
Today's events and market view
Today’s session is light on data which suggests some prepositioning into next week’s events. In US markets also with a view to Monday’s and Tuesday’s Treasury supply. Data remains crucial, both for market and central banks as it increasingly guides their policies. While it was the jobless claims data that triggered a more noticeable retracement of yields, their levels closer to the upper end of recent ranges still signal a preoccupation with concerns around stickier inflation - Tuesday's US CPI release looms large.
While we see only a limited ability of the ECB to move especially longer rates higher, while the skip narrative that has been pushed by the Fed and exemplified by the BoC should also prevent markets from prematurely jumping onto hopes that the Fed could be done. A Fed surprise hike could have more of an impact and invert curves as it further plays into the fears that more tightening could be needed to rein in inflation.
