The FED are back
So last week the ECB hiked but hinted there is light at the end of the tunnel, let just hope it’s not a train! And the Fed around back from their holidays. Let’s take a look.
Last week the ECB took their refinancing rate to its all time high, 4.50%. This caught the market slightly off guard as there was expected to be a hold at 4.25%.
What does it mean? We have mentioned previously about how a hike can be hawkish OR dovish – the devil is always in the detail. Reviewing and summarising the recent statements highlights a few crucial points.
Inflation Outlook: Inflation is on a decline but is expected to remain higher than desired for an extended period. The ECB is committed to ensuring that inflation returns to its 2% medium-term target promptly. The projections for average inflation are 5.6% in 2023, 3.2% in 2024, and 2.1% in 2025. The upward revision for 2023 and 2024 is primarily due to a higher path for energy prices – this is something which could be a major risk for Europe not just in the long term, but in the run up to winter, something I will touch on later.
Growth Outlook: The ECB has lowered their economic growth projections, expecting the euro area economy to grow by 0.7% in 2023, 1.0% in 2024, and 1.5% in 2025 – but have reiterated that they see the slowdown as temporary, returning to growth in Q2 2024. The recent data certainly supports the cooling off in growth but this seems very optimistic to say it’s temporary especially with the amount of risks locally and internationally. It almost seems like the ‘transitory inflation’ comment made by Powell.
The Decision Itself: It all comes back to the fight to reach its 2% target. The ECB appear to by trying to build up credibility – by allowing a decline in growth in order to meet their 2% inflation target. This was likely a difficult decision by the ECB, the traditional remedy for high inflation is the exact thing that kills growth and vice versa so there was never going to be a win/win situation. But was a dovish hike the right way to go?
Next Steps: “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”
What is a dovish hike? Really, this is an oxymoron.
Dovish – This term refers to a more accommodative monetary policy stance. A dovish central bank is more concerned about economic growth and unemployment and is generally in favour of lower interest rates to stimulate borrowing and investment. A dovish stance often implies that the central bank believes that inflation is not a major concern or that the economy needs support.
Hawkish – This term refers to a more restrictive monetary policy stance. A hawkish central bank is more concerned about rising inflation and is generally in favour of higher interest rates to curb borrowing, spending, and potentially overheating economies.
When a central bank implements a “dovish rate hike,” it means that while they are raising interest rates (a typically hawkish move), they are also signalling that they might be cautious about future rate hikes or might even consider reversing the decision if economic conditions warrant. There is always risk around dovish rate hikes. The markets are not static, they are forward looking. By signalling the end to rate hikes – it could be suggested that this may have a stimulating effect on inflation as businesses see peak rates and ‘peak tightness’, and look towards what their operating model may look like in a loose environment. It is unlikely to have as much of an impact on households, as unfortunately not many households are aware of larger economic workings. However, it is likely that the peak is now in for mortgages, both new and variable rates but the risks to inflation are great.
What are the risks? Coming into winter with a war on the doorstep and disastrous weather battering the world, the risks to the supply chains are bigger than ever.
Energy security and prices will play a big role this winter. Last year, Europe escaped with a mild winter. The risks around gas were largely avoided due to the weather. Without wanting to go into too much detail, The EU has a framework in place to ensure the security of gas supply, which is based on improved information exchange, regional cooperation, and solidarity which can be found here (https://energy.ec.europa.eu/topics/energy-security/secure-gas-supplies_en).
Disrupt any one of these supply chains and demand – however much it is depressed due to low growth/consumption – quickly outstrips demands causing prices to rise. Every country has a baseline consumption to keep people fed, keep the lights on and keep the houses warm. I think another mild winter will very much be welcomed by the ECB.
My take on this, is that it’s far too early to say there will be no further hikes and winter will be pivotal but if growth and its outlook worsened it will be very difficult to argue the case for further hikes and really drive Europe into a deep recession. It will take time to see what the impact of 4.5% will have in practice. If the deflationary trend continues – then in the next month or so the talk will shift to “how high for how long?” – but at the minute it’s too soon for any suggestion of cuts.
Across the Atlantic: The number one news event in the financial markets is back after the summer break. Wednesday marks the return of the FOMC – and their September Fed Funds Rate. So, what’s expected? Fedwatch (https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html)
It’s a pretty overwhelming “HOLD”. How has this changed over time?
| Target Rate (bps) | Now (%) | 1 Day (%) | 1 Week (%) | 1 Month (%) |
| 525-550 (Current) | 99.0 | 98.0 | 92.0 | 88.0 |
| 550-575 | 1.0 | 2.0 | 8.0 | 12.0 |
Even as the drivers behind a ‘hold’ decision began to slow or faulter, the expectation of a hold increased.
There is a brilliant piece found at https://corporate.nordea.com/article/84685/macro-markets-disinflation-or-reinflation. This piece looks at a range of metrics linked to inflation and highlights that the path to 2% may not be as smooth. However, with the recent dip in jobs and the associated labour costs this may help fuel the no-hike argument.
Looking at Fedwatch for the November and December meetings, there is an increased chance of a hike – this is likely supported by the associated metrics highlighted in the Nordea piece and what can been seen in several correlated markets.
When everyone is so heavily leaning one way for a decision – there is likely little value left on the announcement alone (if it goes the way people are leaning). It’s again the statement that is interesting here. With a ~33% probability of a hike remaining by the end of the year, there is still plenty of value to be had on a hawkish press release. I do not think anyone will be mentioning cuts until well into 2024 – but stranger things have happened. I personally think the likely outcome is a pretty boring ‘no change, we will see the upcoming data points before committing’.
A brief look at the high level technicals:
Although this is a week where the technicals may be overridden by the fundamentals, it’s important to pay attention to them.
The DXY looks strong, it is approaching a small resistance zone around 105.50 – then it is clear until 108 level, even up to 110.
EXY
A push down towards the 105 level looks on for the EXY.
If there are signs that USD hints at more hikes by the end of the year, coupled with the ECB saying enough is enough last week. DXY moving to 108 would likely send EXY to 105.
Elsewhere – there are other big news events out this week so make sure that you check whether anything can blindside your trade. These include SNB rates, BoE Rates and the BoJ Statement – with the latter being a potential huge opportunity (starting to sound like broken record with the BoJ move)
