Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Macro Insights: Central banks on the agenda – Fed, ECB and Bank of England
Charu Chanana
Chief Investment Strategist
Summary: A slew of key central bank meetings are on the horizon, with the Fed decision due today and the Bank of England (BOE) and European Central Bank (ECB) announcements due tomorrow. Fed Chair Powell has little reason to turn dovish at this point, with risks to inflation emanating from easing financial conditions and China reopening. But a hawkish Powell may only shift the focus back to data. ECB’s hawkishness has some more room to run, much as the BOE’s divide.
Key central bank meetings are due over the next two days, presenting a host of event risks. Markets however remain rather upbeat and are showing no signs of nervousness, with VIX sitting below 20 and S&P500 staring at a key resistance of 4100. Although part of the market rally this week could be attributed to month-end flows, there is some reason to believe we are going into these central bank meetings with dovish-to-neutral assumptions. Let us consider what we can get.
Fed: Powell to emphasize higher-for-longer
With economic data in a Goldilocks situation in the US, the Fed’s likely downshift to 25bps rate hikes makes the most sense as it buys them more time to assess the growth and inflation trajectories. We wrote a preview for the Fed meeting here, but it is worth noting that it is becoming extremely necessary for Powell to push back on the 2023 equity rally and the easing financial conditions especially with the recent rise in commodity prices starting to lift inflation expectations. But will the market care?
Despite Powell’s repeated messages on higher terminal rates, market pricing seems to continue to chart its own path. The key message at this meeting needs to move away from terminal rates to the push back against excessive easing that the market is pricing in, and an emphasis on higher-for-longer interest rates with risks to inflation skewed to the upside.
There is little reason for Powell to be dovish, as he would certainly want to push back on excessive easing priced in by the markets. But a neutral-to-hawkish Powell is widely expected and may likely invoke only a knee-jerk reaction from the markets, offering some tactical opportunities. The US dollar may have some scope to make a recovery but the economic data trends are a bigger piece of the puzzle as of now, and will be a guiding the path for the USD more than the Fed itself. Only a firmer commitment from Powell in either direction, such as a 50bps rate hike or signaling a clear pause (like the BOC), would drive a market reaction that sticks.
ECB: Still scope for upward repricing in the front-end curve
The European Central Bank has surpassed its peers in the hawkishness quotient recently, and will likely repeat that this week. A 50bps rate hike is expected, along with the guidance for another 50bps in March which still has the scope to bump up front-end pricing with markets looking at 93bps of rate hikes over the next two meetings.
Looking further out, about 160bps of rate hikes are priced in for the ECB until mid-year and that limits the scope to surprise on the hawkish side. If Fed proves to be more hawkish than the ECB this week, EURUSD can potentially move towards 1.07. But incoming data, including the Spanish CPI report this week, give the ECB enough ammunition to preserve its current hawkish stance this Thursday. But the 1.0920 resistance has proved tough for EURUSD, and without an upward repricing in the ECB path, that will remain difficult to overcome. EURGBP appears to be an easier pick for this week, with ECB and BOE policy and economic divergences much more evident.
Bank of England: 50 and BOC?
The Bank of England will likely be the trickiest given the indecisive market pricing as well as the scope for a split vote. Broader consensus hints at another 50bps rate hike this week, but a pause signal, potentially not as clear as the one from Bank of Canada (BOC), may also be on the cards. For this, investors will need to read through the Bank’s quarterly inflation forecasts which are also due to be reported this week. Downward revisions to inflation forecasts from November estimates of 1.8% for 2024-end and 0.4% for 2025-end will mean further pricing out of tightening.
Growth risks for the UK economy are also more significant than the other major economies, as also highlighted by the latest IMF forecasts (see below). While the Bank’s own growth forecasts may be subject to an upward revision after a recession was highlighted previously, and data has been more hawkish since, it still seems that the market pricing of the BOE’s path from here remains prone to downside revisions. This leaves little scope of upside on the sterling.
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