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Surprise Fed Outlook Shouldn’t Spook Thinking on Rate Hikes

Northern Trust Asset Management Monthly Market Commentary for June 2021

Eurozone Market Update

The vaccine rollout in the EU continues to progress well after the slow start. At the end of June, 59% of adults have had at least one dose and 36% were fully vaccinated. The European Central Bank kept its main policy measures unchanged and retained its guidance that “purchases under the Pandemic Emergency Purchasing Programme over the coming quarter to continue to be conducted at a significantly higher pace than during the first months of the year.” In the accompanying economic forecasts, both growth and inflation were revised higher for 2021 and 2022, relative to their March projections. Inflation excluding Energy and Food was revised higher throughout the forecast period.

UK Market Update

The Bank of England’s Monetary Policy Committee (MPC) remained unanimous on keeping its bank rate unchanged, and again voted 8-1 to keep the size of bond purchases at £895bn. Members acknowledged that recent economic data was coming in higher than expected, and that CPI inflation is likely to exceed 3% for a temporary period. The MPC also increased its Q2 2021 GDP forecast by 1.5% to 2.3%. However, despite these upward revisions, the BoE continued to stick to its previous guidance of remaining patient to avoid prematurely tightening monetary policy, and reiterated on leaning against downside risks to the outlook. After the meeting, Gilts rallied across the curve 1.5-3.5 basis points (bps) returning to the pre-June FOMC sell off level.

US Market Update

June’s FOMC meeting saw a hawkish surprise in the dot plot outlook. Most members now anticipate two interest rate hikes by the end of 2023, while 7 members expect a hike by the end of 2022. This increased market expectations of rate hikes from the Fed and BoE from Q4 2022, previously Q1 2023 (see chart of the month). As we previously identified, the Fed adjusted its administered rates, with the overnight reverse repurchase agreement facility set at 5bps and interest on excess reserve set at 15bps. The day after the adjustment, rates for dealer repurchase agreements increased to 5bps for Treasury collateral, while Agency and Agency-Mortgages increased to 5.5bps and 6bps respectively. US Treasury bills were 2-3bps higher due to the change.