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Central Banks Hike Rates, Markets Bearish

Key Highlights

  • Investor sentiment was upbeat heading into the Fed meeting week, but stocks quickly declined after Wednesday’s rate hike announcement and press conference.
  • On Thursday, the Swiss National Bank similarly increased its benchmark interest rate by 50 basis points.
  • The Norwegian central bank adopted a more dovish stance, raising rates by only 25 basis points but making it plain that this will likely be the last rate increase until early in 2023.
  • Growing concerns about the economy have caused many central banks to visibly dial back their enthusiasm for rate hikes. 
  • The Eurozone arrived late to the rate-hike party, the ECB will need to keep pushing interest rates higher to control inflation as other policymakers are ready to hit the pause button.
Raise to the top - Major Central banks are all tightening policy to curb inflation

Feds Raised Key Rates by 50 Bps

The S&P 500 is down 1.7% for the week as of Thursday’s market close, the Nasdaq Composite is down 2.5%, and the Dow Jones Industrial Average is down 1.7%.

The 0.5% rate increase by the Fed was exactly what most investors were expecting, and the market had already included it in its expectations. Rather, the accompanying economic estimates and remarks from Fed officials were the primary cause of the unexpected fall.

S&P 500 Index

S&P 500 Index

Jerome Powell reaffirmed the Fed’s commitment to continuing on its current track and bringing inflation down in a press conference following the meeting. Powell stated, “We still have a ways to go. “A sustained period of below-trend growth and some easing of labor market conditions is likely required to reduce inflation.”

This implied that investors should prepare for higher interest rates for longer, possibly accompanied by a recession. The prospect of a so-called “soft landing,” in which the Fed raises rates just enough to prevent a major economic downturn, is still a possibility, although it will be challenging to achieve.

Nasdaq Index

Nasdaq Index

Whatever occurs, the stock market will probably experience some volatility in 2023, whether the Fed is successful or not. In these circumstances, the best course of action for the typical investor is to remain composed, stick with their plan, and carry on making long-term investments in a diversified portfolio.

The Fed made some predictions about how interest rates will change in the future, but the institution is infamous for stressing that each rate decision will be made at a separate meeting.

The subsequent rate increase is scheduled to take place in February, and Chairman Jerome Powell said other rate increases are possible but likely to be smaller. According to him, that will rely on the current state of the economy and the financial situation. 

BoE Votes To Raise Rates Again

Investors gambled that the Bank of England might be nearing the end of its increases in borrowing costs after the central bank increased its benchmark interest rate by another half percentage point on Thursday.

Even with a looming recession and hopes that inflation may have peaked when it hit a 41-year high in October, the BoE’s Monetary Policy Committee voted 6-3 to raise the Bank Rate from 3.0% to 3.5%, its highest level since 2008. The committee was concerned about the risk of persistent domestic inflation pressure from prices and wages.

The BoE’s greatest rate hike in more than 30 years, of 0.75 percentage points, came in November, but only one policymaker, Catherine Mann, wanted to equal it. Two other MPC members voted against raising rates at all.

After the BoE’s pronouncement, the pound dropped below $1.23 versus the dollar and dipped against the euro. It also lost almost a penny against the yen. Indications that interest rates may rise less than anticipated caused the yields on British government bonds to decline.

The European Central Bank announced it was raising rates by half a percentage point shortly after the BoE announced its ninth consecutive rate hike and that additional hikes were expected.

In addition to being concerned about the possibility of a recession, Western central banks are battling post-COVID labor shortages and the inflationary effects of Russia’s war in Ukraine on energy prices.

BoE Votes To Raise Rates Again

The unusual phrasing from November, which stated that rates were unlikely to need to climb as much as markets anticipated, was not repeated in the BoE statement.

Since then, market rate expectations have decreased, and following Thursday’s decision, these revealed investors expected rates to peak at a somewhat lower 4.5% in June 2023. 

British Fight Against Rampant Inflation

In a letter to the finance minister Jeremy Hunt that accompanied the decision, BoE Governor Andrew Bailey stated that the forecasts suggested British inflation had peaked.

According to official data released on Wednesday, consumer price inflation decreased from 11.1% in October to 10.7% in November. The annual rate decreased by 0.4 percentage points, which was the most since July 2021.

Later, in a statement to reporters, Bailey said that statistics showed “the first glimmer” of a dramatic decline in inflation for the upcoming year but added that given labor market conditions, it was still too soon for the BoE to relax its vigilance.

Britain is currently experiencing a wave of industrial action, and in the three months leading up to the end of October, nominal pay—which excludes bonuses—rose at the quickest rate since 2001.

A cap on energy prices included in Hunt’s November budget statement caused inflation in the second quarter of 2019 to be 0.75 percentage points lower than anticipated, according to the BoE, but the impact over the long run would be negligible.

The BoE previously stated that the UK was entering a prolonged recession and forecasted that the economy would contract by 0.3% in the third quarter of this year.

As a result of budgetary actions that provided a temporary stimulus, it now projects a 0.1% decline and an increase in economic output of 0.4% over the next year compared to earlier estimates.

However, greater fiscal restraint would alter the GDP little from the BoE’s November predictions in two years and 0.5% lower in three years than anticipated.

The OECD predicts that Britain’s GDP will decline more than any other economy save Russia’s in the coming year. Government budget experts have warned that consumers will see the greatest squeeze on living standards since records began in the 1950s.

The BoE is also moving on with its plans to spend 80 billion pounds ($1.02 trillion) of its 831 billion pounds ($1.02 trillion) quantitative easing stockpile within a year. At 1800 GMT on Friday, the first quarter of 2023’s gilt sales will be revealed. 

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ECB Gets Hawkish On Rates

The European Central Bank, like the Bank of England, increased its official rates by 50 basis points on Thursday, after initially doing so by 75 basis points, in order to follow the Federal Reserve’s new slower tempo.

However, the two European monetary authorities’ tones clearly differed from one another. Their approaches are likely to diverge in the upcoming months, with Frankfurt continuing to expect higher inflation and London fretting more about a possible recession.

In describing the extent to which it anticipates tightening future policy, the ECB emphasized the word “significantly.” In what was possibly her most hawkish press conference to date, ECB President Christine Lagarde emphasized numerous times that another 50 bps tightening is likely at its next meeting in February, with more to follow.

Based on current market estimates for interest rates, inflation will likely continue above the target in 2025 despite upward adjustments to the central bank’s expectations for consumer price rises in the upcoming years.

According to Lagarde, more needs to be done because current conditions “definitely do not allow a return to the 2 percent inflation target that we have in a timely manner.” Future staff predictions should, presumably, include new market expectations.

Surprisingly, the ECB’s economists do not predict a recession for the upcoming year, instead projecting 0.5% growth. Given the continued high cost of energy, even that meager prediction seems optimistic.

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Author

  • Zahari Rangelov

    Zahari Rangelov is an experienced professional Forex trader and trading mentor with knowledge in technical and fundamental analysis, medium-term trading strategies, risk management and diversification. He has been involved in the foreign exchange markets since 2005, when he opened his first live account in 2007. Currently, Zahari is the Head of Sales & Business Development at TraderFactor's London branch. He provides lectures during webinars and seminars for traders on topics such as; Psychology of market participants’ moods, Investments & speculation with different financial instruments and Automated Expert Advisors & signal providers. Zahari’s success lies in his application of research-backed techniques and practices that have helped him become a successful forex trader, a mentor to many traders, and a respected authority figure within the trading community.