Central Banks Delivered but Markets Think Otherwise

This week we have seen three major central banks lifting their policy rates, but it is obvious that the tightening cycle is slowly coming to an end. Fed’s Powell did not rule out cutting rates in case inflation drops more than Fed expects while ECB set in stone another 50bps hike in March and announced it will then evaluate subsequent path. In this article, we are looking in more detail at the recent central banks’ policies and consequences on the markets.

This week was full of releases with macroeconomic data, a busy earnings season in the US, several monetary policy meetings, and the end NFP that is due today. First, we saw the euro area CPI on Wednesday morning which came at 8.5% YoY which was below expectations, but core CPI in January stood at 5.2%, which is the same level as in December and 10bps higher compared to projections. One should bear in mind that German inflation which constitutes approximately 20% of total EA CPI was estimated by Eurostat as Destatis postponed CPI release due to changes in the CPI calculation. Markets were mainly flat as headline inflation fell significantly while core inflation still stands at highs but also because markets were waiting for the Fed’s decision. In the evening the Fed lifted rates by 25bps as expected and in its statement said that “ongoing increases” would still be required. However, in his Q&A session, Mr. Powell sounded rather dovish, saying that Fed will also be data-dependent and that in case inflation falls faster than Fed currently anticipates, the market could be right in its pricing i.e., that Fed fund rates will reach 5.0% and will be cut at the end of the year. The most interesting part was that Mr. Powell did not negate cutting rates when asked if there is any chance for them to cut rates this year. His Q&A session made bulls blush, with both bonds and equity markets skyrocketing at the same time, giving new investors the flavor of Fed’s printer from the 2010-2021 era.

On the other side of the Atlantic, yesterday BoE increased its rates by 50bps, from 3.50% to 4.0% but the wording of the statement was changed in a way that conditionality was put in the text “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.” And after the BoE, ECB also lifted rates by 50bps, set in stone another 50bps in March but did not say much after that. Namely, in the statement, they said that “it will then evaluate the subsequent path of its monetary policy.” Nevertheless, the most important thing was Ms. Lagarde’s Q&A session in which she said some confusing things. First, she said that ECB will be fully data dependent but only after March as it put another 50bps points for March in the statement. However, later in the session, she said that 50bps is not 100% guaranteed but it is a strong intention for the central bank. Furthermore, she said that after March’s meeting, ECB could lift rates by 50 basis points, 25 basis points, or by any step they feel appropriate. There was not much talk on APP reducing besides that the APP portfolio will decline by EUR 15bn a month from March until the end of June and the subsequent pace will be determined over time. Summing the session, I think that many investors feel confused with the message, as ECB still does not know whether it wants to pursue meeting by meeting approach as it did in 2021 and most of 2022 or wants to give markets some forward guidance like it did in December 2022. In any case, markets saw the latest ECB meeting as dovish and EUR rates saw a significant drop. German 10Y paper yield dropped by almost 20bps while Italian paper with the same duration yielded 30bps lower compared to the day before, meaning that the BTPs – Bund spread tightened by some 10bps to 186bps. Schatz yield decreased by 15bps, from 2.65% to 2.50%.

All in all, this week we have seen central banks slowly informing markets they could soon pause with their tightening and markets celebrated strongly although this is still not a pivot moment. As stated before, investors bought both bonds and equities with strong volumes, as the market now expects inflation to come back even faster than it rose, which would force central banks to pause soon and even cut already this year. In case today’s NFP comes below expectations do not be surprised in case both equity and bonds go higher by another extraordinary move.

Marin Onorato, CFA
Category : Blog

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