The Federal Reserve and the European Central Bank raised interest rates this week, but investors now expect rate regulators in the US and the Eurozone to move in opposite directions.
After 10 consecutive rate hikes, markets are predicting the Powered it has finished its tightening cycle and could start cutting rates as early as July, shifting its focus from containing high inflation to containing a slowing economy.
The ECB, which started raising rates four months later, is expected to raise borrowing costs at least once, and probably twice more this year, according to the overnight index swap market, which sets prices based on expectations of investors on future official interest rates.
“We are in a big divergence in monetary policy on both sides of the Atlantic, which is something quite new,” said Christian Kopf, head of fixed income at Union Investment.
“People in the markets have always said that it’s pointless to make predictions about the ECB because it’s going to make the Fed 200 basis points less and less, but now we’re in a situation where the ECB is really going their own way and will continue to go higher.”
Investor nervousness about the US banking sector has led them to gamble evaluate cuts from the current base rate of 5 to 5.25%, despite annual wage inflation of 4.4% and a job market that remains “extraordinarily tight” according to Fed Chairman Jay Powell.
However, he also warned that the recent banking turmoil appears to “provoke even tighter credit conditions for households and businesses”, which could weigh on economic activity and the labor market.
Meanwhile Christine Lagarde, president of the ECB, signaled more rate hikes to come in a speech on Thursday. “We have more ground to cover and we will not stop, that is crystal clear,” she said, after announcing a hike in the eurozone’s key interest rate to 3.25%.
Investors say the Fed will hold rates until inflation gets close to target and the job market cools, or it will be forced to cut quickly to shore up banks’ balance sheets and curb deposit outflows in the event of a downturn. crisis.
“If they had to cut because of this, they wouldn’t be doing 25 basis points, they would have to be doing 50 or 75 basis points,” said Thanos Papasavvas, chief investment officer at ABP Invest.
Papasavvas and others think that if the US embarks on a crisis-induced rate cut, the ECB would be forced to follow suit.
“Lagarde has tried to push the view that the ECB can continue to tighten no matter what the Fed does [on Thursday] but it is only credible if the US escapes a hard landing,” said Antoine Bouvet, head of European rate strategy at ING.
Others, including Kopf, aren’t convinced. “I think European banks are in much better shape than their US counterparts,” he said, noting that, unlike in the US, all European banks have to comply with the Basel rules on capital and liquidity.
He added that there is no equivalent to the Federal Deposit Insurance Corporation in Europe, so banks and regulators “really make sure they don’t have problems precisely because they know they can’t transfer risk to a federal entity.”
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