13 June 2018
After a few tumultuous weeks on the political front, markets are focusing again on macro conditions, with two key central bank meetings set for this week.
First up will be the conclusion of the two day Federal Open Market Committee meeting on Wednesday, when it is expected to hike rates by 25bp. With strong US growth, solid employment numbers and inflation not too far from target, it is unlikely that the FOMC will disappoint. Beyond the decision itself, investors will scrutinise any change in the Fed’s forecasts and in the ‘’dot plot", for any signs that a faster hiking cycle lies ahead.
Current market pricing is fully aligned with the latest Fed forecasts published in March. Markets are taking a hike this week as a given, and one more is priced in by the end of the year. There is a risk of a hawkish surprise-- perhaps with the Fed hinting at two more rate hikes by December. Such an outcome, however, raises the chance of fuelling yet another round of USD strength and risk aversion, as riskier assets have grown more sensitive to higher US rates and higher funding costs. The Fed is obviously driven primarily by the domestic economy but it can’t ignore the impact its decisions have on global financial conditions, and has worked hard to guide market expectations to where we are now. It is unlikely that the Fed will want to rock the boat.
A similar yet different meeting will be held by the European Central Bank on Thursday. Unlike the FOMC, the ECB is travelling at a very different speed. The ECB is at a much earlier stage of the monetary policy cycle, it is still actively engaged in quantitative easing, and a rate hike is not on the cards for a very long time. The June meeting is now “live” after last week’s comments from Peter Praet, the ECB’s Chief Economist, who sounded confident on the European recovery and that some removal of stimulus is warranted. While investors could receive more details this week, or may need to wait until July or later, the QE programme is in any case widely expected to end this year. Markets should therefore shift the focus to rates and the ECB’s forward guidance.
Macro data in Europe has disappointed of late, with both hard and soft data on a downward trend. On the inflation front, the high print recorded in May, when Eurozone CPI hit 1.9%, gives the Governing Council enough momentum to reduce QE purchases, but it’s likely to be only a temporary spike and should partially retrace by year end. Core inflationary pressures, meanwhile, are still subdued. Against this backdrop, even though QE may be coming to an end, the ECB will keep a cautious tone in the months ahead.
This sets the ECB in contrast to the Fed, and the two central banks will remain on diverging policy paths.
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