Markets Scale Back Rate Rise Expectations in Reaction to Omicron Variant

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

Eurozone Market Update

Communication from European Central Bank members continues to stress that they expect the current high inflation levels to be transitory. Members also emphasised that conditions for rate hikes are unlikely to be met in 2022. In October’s monetary policy meeting, members indicated that the current market pricing of rates suggest the central bank’s guidance is not understood. Furthermore, the view was held that net purchases in the Pandemic Emergency Purchasing Program (PEPP) could end by March 2022. Members believe it is important to keep sufficient optionality after the December meeting. In Europe, news of the Omicron variant saw money markets push out to 2023 the 20 bps of hikes that had been priced in by the end of 2022.

UK Market Outlook

At November’s Monetary Policy Committee meeting, the Bank of England voted to keep rates at 0.1% and left the quantitative easing programme unchanged. This surprised many in the market who thought a rate hike would occur. It was indicated that most of the committee members might want more than a month of post-furlough data before any rate rise. The first set of post-furlough data was positive, with a 14,900 fall in jobless claims for October. Furthermore, the numbers for September were revised lower to a decline in jobless claims of 85,000 from 51,000 prior. However, news of Covid-19’s Omicron variant saw the money markets pair back rate rise expectations. At the time of writing, a hike of 9 basis points (bps) is priced in for December and a 27 bps hike is priced in for February, down from 16 bps and 57 bps hikes, respectively, at the beginning of the month. This resulted in a volatile month (see chart of the month).

US Market Outlook

In November, concerns over inflation increased market expectations for multiple rate hikes in 2022. The markets also viewed the re-nomination of Jerome Powell to be the Federal Reserve chair as a hawkish decision. There had been speculation that President Joe Biden may select Lael Brainard instead, who is perceived to be more dovish than Powell. There is still no resolution to the debt ceiling, despite Treasury Secretary Janet Yellen informing Congress that the Treasury will run out of money on December 15. There is scepticism in the market on the exact default date, with some investors estimating the end of December and even early January. The Treasury bill curve is currently showing most of its concern in late December, with bills in this period trading 4-7 bps higher.

Global Outlook

All three central banks meet in December. If the labour data released two days prior to the Bank of England meeting is good, it may be sufficient for further members to vote for a rate hike. However, with some members still advocating a wait-and-see approach, this may not happen until February. The improving labour markets and high inflation caused the U.S. market to price in multiple rate hikes in 2022, with speculation the Fed may accelerate the taper at the December meeting to facilitate this change in timeline. However, decisions on policy tightening from both the Fed and Bank of England may be taken out of their hands due to the rise of the Omicron variant. This could pose downside risks to employment and economic activity and further uncertainty on inflation.

Chart of the Month: Recent Volatility in Short Term Debt Instruments

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