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Markets Pause for Breath as Diverging Central Bank Approaches Continue

Northern Trust Asset Management Monthly Market Commentary for August 2021 - Exclusive Insight for TMI Subscribers

Eurozone Market Update

Seasonal calm is at work in Europe. With no significant European Central Bank (ECB) meeting in August, front-end Euro rates remained subdued. However, ECB Chief Economist Philip Lane assured investors that asset purchases will continue unabated in a number of scenarios, including any negative spill-over from Fed tapering. The ECB could increase buying in reaction to any upward pressure on European bond yields. This underlines a policy divergence between the ECB and the Fed once they begin to taper (with the Fed reducing purchases, the ECB maintaining them). Generally this month, economic data­ – including the Purchasing Managers’ Index, inflation and gross domestic product – all came in strong as expected, with little change in lockdown restrictions across Europe and an uptick in the vaccination rollout.

UK Market Update

As expected, August’s Monetary Policy Committee meeting saw the Bank of England (BoE) vote unanimously to keep rates unchanged. The key takeaway from the meeting was that sequencing of policy tightening would still see rate hikes before reducing the balance sheet. That said, the BoE’s previous 1.5% hurdle base rate, before reducing the balance, has now been lowered to 0.5%, and suggested active selling of assets may yet occur once the base rate gets to 1%. The market greeted the mild BoE hawkishness with a muted reaction, especially at the front end of the curve. A 15bps rate hike is priced in for Q2 of 2022 and a further 25bps hike is priced in for the end of 2023 (see Chart of the Month). Post-meeting, the Sterling overnight index swap curve steepened slightly, with the one-year curve ticking up 2bps.

US Market Update

Fed Chair Jerome Powell’s speech at Jackson Hole at the end of the month provided no new information on rates and tapering. He remains cautious on timing, even after several Fed speakers called for an accelerated start of tapering, with some suggesting September. Powell stated that the timing and pace of the reduction in asset purchases should not be viewed as a direct signal regarding rate hikes, which demand a different and substantially more stringent test. The speech was all about keeping Fed options open for this year. The exact month of action on tapering doesn’t matter as much, given investors already anticipate it.