Interest Rate Expectations Extremely Bearish For ECB Next Week
- Interest Rate Expectations Extremely Bearish For ECB Next Week
- Federal Reserve Helps Weigh on the Global Rate Outlook
- BoE, BoJ and SNB Off the Rates Radar but Active with Monetary Policy
Rate Expectations Commentary
The Fed rate decision proved a turning point for sentiment in the broader financial markets by undercutting confidence that has long subsisted on a steady diet of stimulus (moral hazard to some) as well as accelerating the negative shift in interest rate expectations. We will be feeling the repercussions of the US central bank’s decision to pursue an ‘Operation Twist’ policy approach instead of an outright QE3 program for months. This isn’t because this decision will provide an active selling point. Rather, it has withdrawn a very widespread and important safety net for the world’s investors and exposed the anemic rates of return which seemed to have traders salivating over for the past few years.
This highlights an interesting phenomenon for the markets – as risk appetite drops, so too do interest rate expectations. We have seen the clear effects of this across the board on the rate outlook table above. Considering each trade is made on the basis of some imbalance between risk and reward; we are seeing both the risks to the market build while the yield that could increase our tolerance for fear similarly dissolves. This is one of those instances where we see an underling shift in sentiment where the markets are now more responsive to negative developments and less responsive to the positive.
For current highlights in rate analysis, speculation is heaviest surrounding three particular policy groups: the European Central Bank (ECB), Bank of England (BoE) and Reserve Bank of Australia (RBA). The ECB has worked its way to the top of the list as policy officials have signaled they are considering a return to expansive monetary policy to help fight the regional crisis. Currently, the market is pricing in a certainty of a 25bp cut next week; and there is further heavy debate about a 50bp cut at the meeting – perhaps in an effort to jump start confidence. However, there is an alternative opinion starting to gain traction that the central bank will go for unconventional policy (covered bond purchases) before they move on rates. This is a real possibility; but the net effect on the euro would be the same.
The RBA is expected to be the most active major central bank over the coming 12 months with 137bps worth of cuts priced in over the coming 12 months. However, we have noticed a marked retracement in immediate dovish/bearish speculation recently. Rather than pointing to the reduction in the 12-month rate cut forecast; we are looking at the market probability of a cut at the next RBA policy meeting (next week). From near certainty, the masses now see a 37 percent chance. It will likely further reduce as it approaches. To really encourage the Australian dollar though, we will need to see this translate into a significant drop in the rate forecast further out.
Finally, we should keep a close eye on those policy groups that are not actively discussing rates; but are more interested in adopting other policies for easing financial strains. The ECB is arguably considering this tack; but it is the BoE that is almost assured to take this road. With a 0.50 percent benchmark, there isn’t much room to cut. Instead, the Monetary Policy Committee (MPC) is more likely to follow Adam Posen’s line of reasoning - increase bond purchases by 50 to 100 billion pounds. Less conventional; but just as influential, we should also monitor SNB and BoJ. Speculation is still circulating the Swiss central bank will raise its floor on EURCHF from 1.20 to 1.25. And, should the yen threaten to mark any further progress from near-record highs, the BoJ will be tempted to follow suit as new record highs for the currency burden the economy.
Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com
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