While market participants are rather certain about the size of the Fed rate hike, there is less consensus about the ECB rate hike
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This week is like no other - earnings of major companies like Apple and Alphabet are released and major central banks decide on interest rates. For stock market, tomorrow Fed decision could be shocking if Federal Reserve goes for a 50bp, but until now, the 25bp rate hike seems to be almost sure, but does it mean market will do nothing about it? Speaking of ECB, at this central bank the situation isn't that clear according to Conotoxia's analyst comments.
For the first time since summer, the Fed rate hike of 25 bp is indeed cemented. Are you of the opinion there will be no real market reaction though?
Indeed, the majority of the market participants expect the Fed to increase the interest rate by 25 bp, the smallest increase since the meeting on 16 March 2022. This expectation is based on the seemingly slowing inflation in addition to other factors hinting in favor of the “soft landing” as well as the 5% ceiling set by the Fed themselves. As the current rate of 4.5% is rather close to 5%, Fed officials seem limited in their ability to raise the rates further. Meaning that a rate hike of 50 bp would already reach the set ceiling and would not allow room for action in the future.
While we could say that a higher than 25 bp hike would shake the markets considerably, the currently expected 25bp hike may pose uncertainty. Typically, economic data reported exactly in line with expectations may be perceived with no major reaction from the market or even a slightly positive reaction (read: no news is good news). Meanwhile, financial markets are currently extremely volatile as investors are willing to believe that the stock market depreciation is over but still, they may be ready to jump out of it as soon as they feel any hint of a bearish trend returning.
I would also emphasize to keep in mind that last week saw a very bullish action within stock markets around the world. As any trend is more of a wavy pattern with corrections, the Fed interest rate announcement on Wednesday may be the one that triggers a short-term correction in the current uptrend. This, combined with the sentiment discussed above, indicate that there may be a potential for a market reaction to a 25bp rate rise.
How do you see possible effects of the ECB decision? Is the hike in prices already?
ECB interest rate decision is planned after the Fed announcement on the same subject later this week. While market participants are rather certain about the size of the Fed rate hike, there is less consensus about the ECB rate hike. There may be a higher possibility that the ECB raises the interest rate by 50 bp in comparison to the Fed. Firstly, the current eurozone interest rate is lower than in the US: 2.5% in the eurozone vs 4.5% in the US, giving the ECB room for more aggressive monetary policy.
Secondly, Consumer Price Index data show that the eurozone has not managed to curb inflation as well as the US (the latest YoY reading for December 2022 was 9.2% in the eurozone versus 6.5% in the US and is forecasted to be 9% and 6.5% respectively in January 2023). Eurozone’s newest preliminary CPI YoY reporting will be released on February 1 and may impact the ECB’s decision on the interest rate hike size later this week.
If the ECB announces the interest rate increase of 50 bp versus Fed’s 25 bp, we may see a bullish effect on the Euro versus the US Dollar.
Santa Zvaigzne-Sproge, CFA, Head of Investment Advice Department at Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement, or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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