The Central Bank Tightening Party: Who Will Be Next To Join?


The Fed has been hosting the tightening party since December 2015, but has been very lonely.  A couple of weeks ago, Stephen Poloz and the Bank of Canada showed up with their own 25bp hike.  Other central banks seem to be thinking about joining the party as well.  Meanwhile the Fed, after being alone for so long, is considering slowing the pace of rate hikes.

 

While they haven’t yet RSVP’d, Sweden’s Riksbank, the Bank of England, the Reserve Bank of Australia, and as of last week, the ECB, have all started signalling that they may join the party in the next year if not earlier. 

 

 

Bank of Canada

The loonie has jumped 2.5% since the BoC hiked, and the market is expecting another hike before year end.  While we think hindsight will show these hikes to have been a policy error (inflation well below target, housing bubble deflating if not bursting which will translate into a negative wealth effect and weight on consumer spending, extremely stretched household debt servicing costs jumping) the short term impact will be continued strength for CAD. CAD has strengthened 7% year-to-date.

 

 

ECB

Whilst the ECB statement was quite dovish, the market jumped on the comment that a discussion on tapering will likely happen in the fall, which could be as early as September.  The market is now pricing in 10 bps of hikes by September 2018.   The FX markets jumped on this first indication of a discussion on tapering, as well as the fact that Draghi had ample opportunity to express concerns on the strength of the EUR (which he almost always does) but let the opportunity pass.  EURUSD rallied 100 pips during the press conference.

 

 

Bank of England

The BoE’s Monetary Policy Committee surprised the market last month when the minutes showed that 3 of the eight members had voted for a rate rise, even in the face of Brexit.  The market is now expecting a hike at some point during the course of 2017.  GBPUSD has rallied 3% since the June meeting, and almost 7% year to date.

 

 

Reserve Bank of Australia

The markets are now pricing in a 60% chance of a rate hike in the first half of 2018, after the RBA indicated that the neutral rate of interest is 3.5%, 2 full percentage points above where it is now. I’m not sure they meant to have their statement interpreted as a signal that they intended to raise rates, but AUDUSD has jumped 3% since the June meeting, and 10% since the beginning of the year.

 

 

Sweden’s Riksbank

The Swedish central bank has been referring to rate hikes in their statements since April, although pointing to a likely tightening in mid-2018.  With inflation running above target, this schedule may be accelerated.  While SEK has already appreciated vs USD by almost 11% year to date, the Riksbank may be quite happy to see that strengthen even further to act as a pseudo tightening of policy until they are ready to take action.

 

 

US Federal Reserve

Just when the party is getting into full swing, the Fed looks like it’s having some second thoughts and is indicating that the pace of rate hikes might slow down somewhat.  If that turns out to be the case, then expect the wide yield spreads to these other countries, which have for so long been USD supportive, to continue to narrow, which will point to a weaker USD going forward.

 

 

It looks like just as the guests are arriving at the Central Bank Tightening Party, the hosts are going out for a walk.

 

 

Author: John Glover



 

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