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Bid Adieu to negative rates

by Seerat Fayaz   ·  February 9, 2022   ·  

Bid Adieu to negative rates

by Seerat Fayaz   ·  February 9, 2022   ·  

#edgeforex #trading #market #stocks #money #forex #inflation #dollar #price #hwkish #negative #forecast #adjustment #cryprocurrency #bitcoin

Continued upside inflation shocks and hawkish ECB remarks have resulted in more rate hikes in the Eurozone profile. Tighter ECB policy offers up more upside for longer term rates but also limiting how low the EUR/USD may go. 

The ECB has followed in the footsteps of many other central banks in becoming more hawkish, and we have added rises to our ECB projection profile. Market pricing for the Fed’s forecast has also gotten more hawkish, but we continue to believe that quarterly 25bp rate rises are a solid baseline. In a nutshell, we anticipate the Fed to raise rates by 25 basis points four times this year, beginning in March, followed by four more rises in 2023. During the summer, a decision will be made on whether to allow the balance sheet to contract.

In March, the ECB will decide to terminate net bond purchases towards the end of August. Rate increases of 25 basis points will be implemented in December 2022, March 2023, and September 2023. 

EUR/USD is expected to reach a low of 1.10 later this year and a high of 1.18 by the end of next year. 

Long term rates will continue to rise, but the yield curve will flatten from present levels by the end of the forecast horizon. 

The ECB is becoming hawkish. 

The ECB’s hawkish shift last week took financial markets off surprise. Following the ECB meeting, for example, the 5-year EUR swap rate increased by the most in more than 10 years in only two days. 

We now envisage three 25bp rate increases during our projection horizon to the end of 2023, based on the ECB’s signals and higher revisions to predictions, which now show Euro-area core inflation staying over the ECB’s 2 percent objective for the majority of the forecast horizon. 

We continue to believe that market pricing of more than 50bp higher overnight rates, i.e. two 25bp rate rises, until the end of the year is excessive.

After all, Klaas Knot, one of the most hawkish ECB Governing Council members, has stated that the first ECB rate rise would occur in the fourth quarter, followed by another in the spring. Furthermore, according to a Financial Times piece citing ECB sources, even more hawkish ECB officials saw a rate rise this summer as implausible. 

One should not rule out the possibility of the scenario priced by financial markets materialising entirely. After all, the ECB only a few months ago informed us that a rate rise this year was quite improbable — now it isn’t.

A few of further positive surprises in inflation and/or shockingly strong pay growth data might lead plans to be implemented as early as September. However, based on existing knowledge, we believe that the present pricing for this year is excessively aggressive. 

A quick tightening of financial conditions is a significant risk element for the ECB. While funding circumstances remain favourable, they have begun to tighten fast. Nonetheless, it is critical to distinguish between the Eurozone’s predicament last year, when the ECB was undershooting its aim, and the argument that favourable financing conditions were necessary to assist push inflation to the target.

If the ECB is approaching the point where it needs to control inflationary pressures, tougher lending conditions are the tools to that end. Still, a sudden tightening is unlikely to be in the ECB’s best interests, and additional increases in e.g. bond spreads may heighten concerns that the ECB cannot tighten policy too forcefully, limiting the pricing of ECB hikes.

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