Swissquote Bank: Fed done, ECB and BoE to go

16 december 2021

By Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank

A relief rally following the Federal Reserve (Fed) meeting is what’s in play right now, as decision on Wednesday, though hawkish was mostly priced in.

The Fed announced it will double the pace of QE tapering by buying $ 30 billion less Treasuries and MBS for the months ahead. It will be done with the asset purchases altogether sometime early 2022, then will come the first rate hike by spring. And according to the median forecast of the famous dot plot, the first spring rate hike won’t be the last; the Fed would proceed with two more rate hikes during the course of next year.

The abrupt change in the policy is obviously due to the rapidly rising, and sticky inflation, and the strong improvement achieved in the labour market.

Jerome Powell said yesterday that the US labour market is hotter than it ever was by many measures. Despite 4 million more jobless people compared to pre-pandemic times, the Fed did the best it could to improve the labour market conditions, yet its influence gets soft by the day. Therefore, it is now time to focus on things that it could influence: inflation.

The major US indices first fell then rebounded. And the rebound was rather strong. The US tech giants had a great session; the announcement that there will be a 75bp hike next year didn’t hit the investor appetite for these giant growth stocks. So, at this point, I am really wondering if we will ever see the reflation trade happen… The value stocks will sure progress well, but I am not sure they will outperform their tech peers.

Now it’s Europeans turn to announce their latest monetary verdicts.

The inflation talk is heating up in Europe as well, and the latest inflation data in Britain showed that inflation exceeded the 5% mark in November, while the BoE was expecting to end the year somewhere near 4%.

Yet, no one expects to see a rate action from the BoE today. Nor from the ECB. And of course no action from the Swiss National Bank which swiftly follows the ECB in its decisions.

In the UK, the first rate hike is seen at the next meeting, and the chances are that we see a 20bp hike instead of a 10bp one. There is always a chance that we see a surprise hawkish action today, but the probability of such move remains quite low. Cable will likely extend losses in the coming sessions and the bears will aim an advance to the 1.30 mark in the coming weeks.

For the European Central Bank, it’s complicated. The ECB must deal with a many countries that have many different needs, so making a policy decision is hard, and takes time. But the rising inflation will heat up the discussions of a tighter policy as well, because the Germans, the Dutch and the Austrians are tenser by the day as inflation explodes.

Meanwhile, Christine Lagarde is still on ‘inflation is transitory’ rhetoric, and that must change. But the day that the T word is spelled out, the policy response should come fast. Yet, the delta is wreaking havoc in Europe this winter, and the omicron threat is real. Therefore, it could be another meeting Christine Lagarde turns a blind eye on inflation.

This being said, the hawkish risks prevail, preventing the EURUSD from extending gains below the 1.13 mark. Now that the FED hawkishness is priced in, we are left with the ECB hawkishness to price in. That will happen sooner rather than later, and encourage a recovery to 1.15 mark at some point in the medium run.