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Markets Seek Higher Terminal Rates

Markets Seek Higher Terminal Rates

Major central banks around the world have raised rates at an unprecedented rate in an attempt to curb inflation, which in some countries has reached or is approaching a 40-year high. However, the question remains when they will stop raising tariffs and what the terminal tariffs will be. The chart below shows where some major central banks have currently set rates, as well as where the market expects rates to be in a year from now. For your guide, all of these rates are higher than the policy rates implied after 2 years. This means that markets expect central banks to cut rates after peaking in a year.

Source: Stone X, Bloomberg.

US Federal Reserve

The US Federal Reserve has currently set the federal funds rate at 4.00%. The Fed is expected to raise rates during the year to 5.22%. The Fed has raised rates by 75 basis points in the last 4 meetings in a row! Markets are now wondering if the Fed will slow down its pace of rate hikes at its December meeting. The statement said that “in determining the pace of rate hikes, we will take into account cumulative tightening, policy backlogs, and economic and financial developments.” At the press conference that followed, Fed Chairman Powell said the final rate mattered more than the pace of the tightening, but the committee didn’t even consider stopping the rate increase. The FOMC will meet again on December 14th.

European Central Bank

The European Central Bank is currently maintaining rates at 1.50% from a pandemic low of -0.50%. The ECB is expected to raise rates to 3.11% during the year. The ECB raised rates by 75 basis points at its last meeting, raising the deposit rate to its highest level since 2009. The central bank said it plans further rate hikes depending on rising inflation and economic developments. Also, recently ECB members, including ECB President Christine Lagarde, have come out of the line to discuss that inflation is too high and rates still need to be raised. The last value of inflation was 10.7%. The ECB will meet again on 15 December.

Bank of England

Bank of England rates are currently pegged at 3.00% after the Bank of England raised rates by 75 basis points at its last meeting. The Bank of England is expected to raise rates to 4.74% during the year. However, after the November meeting of the Bank of England, the Committee was quick to point out that peak interest rates were likely to be lower than markets had anticipated. In addition, the committee noted that if the market follows its current market curve, the UK could be in recession for the next 2 years starting in the third quarter of 2022 (results due November 11). Note that the latest UK inflation figure was 10.1%. The Bank of England meets again on 15 December.

Reserve Bank of Australia

The Reserve Bank of Australia is currently maintaining rates at 2.85% after the RBA raised rates by 25 basis points at its last meeting. This was the second consecutive increase of 25 basis points, although the Committee said it planned to continue raising rates. The annual target for the rate is 4.24%, which means that if the RBA wants to continue raising rates by 25 basis points, it will have to do so 6 more times over the next year. On November 4, in the Monetary Policy Statement, the Committee raised its inflation forecast to 6.5% (the preferred target for trimmed average inflation). And as recently as Nov. 9, the RBA’s Bullock reiterated that further increases would be required as wage growth was slightly higher than 3 months ago. The RBA meets again on Tuesday 5 December.

Bank of Canada

The Bank of Canada currently has an overnight rate of 3.75%. The annual rate expectation is just 4.35%, just 60 basis points above the current level. The Bank of Canada surprised the markets at its latest meeting by raising rates “only” 50 basis points against an expected rate hike of 75 basis points. As with other central banks, the Bank of Canada said it intends to raise rates further to curb inflation as the committee’s preferred measure of inflation (the core consumer price index) showed no signs of easing. The October employment report was +108,300 against expectations of just +10,000. This should give the Bank of Canada confidence in the need for further rate hikes. The Bank of Canada meets again on December 7th.

Reserve Bank of New Zealand

The Reserve Bank of New Zealand has now set rates at 3.50% after raising the official exchange rate by 50 basis points at its last meeting, but a 75 basis point rate hike was discussed. While the RBNZ appears to be the next hawkish central bank after the Fed, its annual inflation target is high at 5.37%. The committee noted that further rate hikes are expected, but also considered that there was a lag in the transmission of monetary policy. Will the next rate hike be 50 basis points or 75 basis points? RBNZ meets again on November 23rd.

Bank of Japan

The Bank of Japan kept interest rates firmly at -0.1, where they have been since the start of 2016. The central bank also left the 10-year JGB ceiling at 0.25%. However, inflation has increased and its last reading was 3%! Therefore, markets expect the Bank of Japan to “do something” next year. Therefore, the implied annual inflation forecast is +0.10%. Despite rising inflation, the Bank of Japan maintains that the current inflation is driven by energy and fresh food and will therefore take further easing if necessary. He will also continue to buy bonds against the 0.25% limit on 10-year bonds. The Bank of Japan is not meeting again until December 20th.

Joe Perry, CMT, FOREX.com » Official site

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Disclaimer: The information and opinions contained in this report are for general information only and do not constitute an offer or solicitation to buy or sell any currency contracts or CFDs. Although the information contained herein has been obtained from sources believed to be reliable, the author does not warrant its accuracy or completeness and shall not be liable for any direct, indirect or consequential damages that may result from anyone relying on such information.

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