Lift Off for Fed Rate Rises

Northern Trust Asset Management Monthly Market Commentary – Exclusive Insight for TMI Subscribers

Eurozone Market Update

While leaving interest rates unchanged, the European Central Bank (ECB) was more hawkish than market expectations in reducing Asset Purchase Programme (APP) net purchases sooner, meaning asset purchases could end in Q3. The language on rate hikes also changed from "shortly after” to “sometime after” the net purchases in APP have ended, giving the ECB more flexibility on rate hikes. The ECB forecast also revised economic growth lower due to war in Ukraine and slowing demand, and revised inflation higher as surging energy/commodity prices may pressure other sectors. Investors’ expectations on rate hikes increased through the month, pricing close to a 20 basis points (bps) hike by July (up from 5 bps) and 55 bps by the end of the year (up from 13 bps).

UK Market Update

The Bank of England (BoE) voted 8-1 to hike rates 25 bps to 0.75%, in line with expectations. The lone dissenter voted for no change, and the meeting was more dovish than February when four members voted to hike by 50 bps. Since then, the war in Ukraine has increased uncertainty, while inflation has surged with rising energy prices. Higher inflation’s negative impact on real income is now likely to be materially more significant than predicted in February. This will reduce household spending and savings in the coming months. Markets are currently pricing five rate hikes by the end of the year, a slight increase from the beginning of the month.

US Market Update

The Federal Reserve increased interest rates by 25 bps and raised the reverse repo program and interest on excess reserves by 25 bps each. The new dot plot (see Chart of the Month) shows the median forecast for a 1.875% rate by the end of 2022 and a terminal rate of 2.375%, highlighting that the Fed is looking to front-load rate hikes in 2022 followed by more limited hikes. The Federal Open Market Committee also downgraded expected economic growth from 3.6%-4.5% to 2.5%-3.0% and increased their inflation expectations in core personal consumption expenditures from 2.5%-3.0% to 3.9%-4.4%. Fed futures contracts are pricing eight rate hikes in 2022, with a 78% probability of a 50 bps hike in May.

Global Outlook

The ECB is the sole central bank meeting in April, and we do not expect any policy announcements. Instead, we will be watching how the balance between the hawks and doves on the committee shifts for insights on potential rate hikes. We still believe the market is over-estimating the number of ECB hikes this year and expect this to be below the 55 bps priced in. Speeches from BoE and Fed committee members will provide insights into how they could vote in May. We are seeing a divergence emerge between the two. Having been behind the policy tightening curve, there is an increasing chance the Fed will hike 50 bps. Meanwhile, the BoE is raising some concerns about the outlook for growth and medium-term inflation if rates increase too far.

Chart of the Month: Fed Dot Plot Fuels Expectations for Major Rate Hikes in 2022

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