Monetary Policy Continues to Drive Markets as Ukraine Invasion Weighs on March Meetings

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

Eurozone Market Update

The European Central Bank (ECB) unanimously agreed to leave key interest rates and forward guidance unchanged, along with its December guidance on asset purchases. The ECB expects the next few months to be difficult for economic output before a rebound in the second half of the year. The ECB believes inflation will be below target by the end of 2022, however, the risk is to the upside. Following a hawkish press conference from President Lagarde, the March ECB meeting will be interesting due to its potential for new guidance on rate hikes and asset purchases. The swaps market is now pricing in the potential of three, rather than four, 10 bps hikes by year-end.

UK Market Update

The Bank of England (BoE) delivered the 25 bps rate hike in February as we anticipated, taking the base rate to 0.50%. Surprisingly, four of its nine Monetary Policy Committee (MPC) members dissented, voting to hike rates 50 bps to 0.75%. This followed a sharp upward revision of inflation projections for 2022, with an expected peak of 7.25% in April. Later in February, in testimony to the U.K. Treasury Select Committee, some MPC dissenting voters softened their rhetoric, and noted that their decision was “finely balanced” and that “only really modest tightening is needed to get inflation to target.” The swaps market had been pricing in six 25 bps hikes in 2022, with an 80% chance of a 50 bps hike in March. This has now reduced to five hikes and an 8% chance.

US Market Update

With no Federal Reserve meeting in February, the market focused its attention on key economic data. January non-farm payrolls increased by 467,000, significantly higher than the market expectation of 125,000, while the unemployment rate ticked up to 4.0% from 3.9%. The biggest news was a 7.5% rise in year-on-year headline inflation – its highest rise since 1982. Two key indicators were also up – the Consumer Price Index grew 0.6%, while the Producer Price Index rose to 1% versus market expectations of 0.5%. The Fed's James Bullard caused a significant repricing of the curve after the inflation data release when he suggested the Fed should be open to an inter-meeting increase and delivering 100 bps of hikes by the beginning of July. Fed Future contracts ended February by pricing in more than five rate hikes in 2022, with a 10% probability of a 50 bps hike in March.

Global Outlook

The geopolitical events in Ukraine will dominate headlines in the near term, feeding market volatility. All three central banks meet in March, when both the Fed and BoE are expected to hike rates. The political situation won’t stop this, but it may affect the number of hikes they deliver in 2022. In Europe, thoughts that the ECB could recalibrate their monetary policy and signal an early end to quantitative easing are now less likely, after President Lagarde commented that the Bank will do whatever is needed to defend price and financial stability. The impact of the invasion of Ukraine on economic growth is clearly negative, but it is too early to measure its full effect. A more predictable and cautious path for monetary policy might well be more critical for financial markets at this stage.

Chart of the Month: Month-end Slump in Implied Rates Highlights Market Volatility

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