Inflation and central banks continue to set the tone in global financial markets. US inflation for January rose by more than consensus reaching 7.5%, which is the highest level in 40 years. The core inflation measure also surprised on the upside, reaching 6% y/y. After the inflation print, Fed governor James Bullard argued that the Fed should increase the Fed funds target range by 100bp no later than July and that it may be necessary to hold an emergency meeting to get started before. However, some of the more centrists Fed members cautioned at moving too fast through an emergency hike or a 50bp rate hike as the first move. Markets are now pricing in 6.5 rate hikes by year-end and even a 5-6bp rate hike here in February, i.e. a non-negligible probability of an emergency rate hike. In addition, the markets are very close to fully price in a 50bp rate hike by March. We expect the Fed funds target range is raised by at least 50bp in March with the possibility of an emergency meeting move in the form of a rate hike or early end to QE. We are currently reviewing our Fed call of five rate hikes (125bp) this year.
The ECB seems more split on its tightening policy. President Christine Lagarde said that she favours a gradual approach. In an interview with Redaktionsnetzwerk Deutschland, she warned ECB could harm the economy’s rebound from the pandemic if it were to rush to tighten monetary policy. Raising interest rates “would not solve any of the current problems,” she stated “On the contrary: if we acted too hastily now, the recovery of our economies could be considerably weaker and jobs would be jeopardized.” This was echoed by Banque De France governor, Francois Villeroy. In contrast, the more hawkish members of the governing council like Dutch central bank governor Klaas Knot said this week that he sees the first rate hike in 2022
In contrast, Riksbank seems even more relaxed about inflation pressures and the need to tighten policies and China central bank is easing policies. At its policy meeting this week, Riksbank (as expected) revised the inflation forecast higher, but stressed that there were not yet any second round effects into core inflation. As for the repo rate path there were only minor changes made in comparison to the November meeting, lifting it slightly signalling a first full hike in H2 2024. Chinese credit growth gained speed in January following easing of monetary policy in recent months.
Next week, central bank speakers both from the US and Europe will be in focus. Furthermore, In the US, we are looking forward to retail sales on Wednesday, especially in the light of the still skewed consumption pattern and high inflation. Besides that we receive FOMC minutes, where we will look for details about quantitative tightening and the 25bp or 50bp hike question.
This week the bond market sell-off continued. The US 2 year treasury yield increased by 30 bps while the 10 year US yield breached 2%. We now expect that 10Y US Treasury yields will rise to 2.45% (from 2.25%) in the course of the next 12 months. We also raised our 12M target for 10Y German Bunds to 0.60%, see our Yield Outlook: Upcoming ECB and Fed rate hikes pushing long yields higher, 10 February. Equity markets remained relatively resilient during the week.
