Powell’s Hawkish Comments Drive Market to Price In Five Hikes

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

Eurozone Market Update

The European Central Bank (ECB) remains more dovish than other major central banks, with expectations that inflation would move below target towards the second half of the year. There is a balanced view that monetary tightening is not required at this stage. Should inflation be higher than expected, we think they will react. Eurostat’s data showed euro area headline inflation up by 0.1% to 5.0% year-on-year in December, while core inflation was stable at 2.6% year-on-year. The dropping out of the base effect linked to Germany’s value-added tax cut, along with easing supply chain constraints, services reopening, and energy prices normalising have all contributed. Unemployment has declined sharply in recent months, down to 7.2%.

UK Market Update

Bank of England (BoE) officials were quiet in the run-up to February’s monetary policy meeting, leaving critical economic data to guide markets. This included the November labour market report, which indicated that employment fell in October and November. The end of the furlough scheme hurt employment less than feared, though it did have an impact. Average wage growth contracted by 1% year-on-year while headline inflation outpaced expectations with a three-decade high of 5.4% growth year-on-year. Services inflation continues to firm, which will be on the BoE’s radar. The gilt market sold off this month due to the higher inflation and increased expectations of rate hikes from central banks in developed markets.

US Market Update

At January’s Federal Open Market Committee (FOMC) meeting, officials left rates unchanged at 0-0.25%. However, both the meeting statement and post-event press conference saw Federal Reserve Chair Jerome Powell continue the hawkish narrative seen since the end of Q4 2021. With unemployment at 3.9% and continued concern about rising inflation, Fed officials signalled “it will soon be appropriate” to raise policy rates. Powell did not rule out the possibility of a 50 bps hike in March or raising rates at every FOMC meeting, depending on data. The market viewed the post-meeting press conference as very hawkish, pushing up yields across the curve. Fed funds futures are now pricing in five rate hikes for 2022 (see Chart of the Month).

Global Outlook

Both the BoE and ECB meet on 3rd February. We expect the BoE to hike rates a further 25 bps, taking the base rate to 0.50%. We also expect quantitative tightening to start once economic data from both inflation and employment is strong enough. However, as the past two meetings have proved, the BoE can be unpredictable. With the focus of the ECB meeting, investors will be looking at whether the bank continues to diverge from the UK and US central banks on their inflation outlook. They also will look for early indications of the appropriate time to tighten policy, something we believe will not commence in 2022. Finally, we will monitor Fed officials’ speeches to see if they are supportive of Powell’s hawkish views or if the market misread the comments.

Chart of the Month: Hawkish Fed Have Investors Asking “How Soon, How Much?”

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