Have financial markets reached a bottom yet? Or is there more room on the downside? Investors, keen to find out how close to the bottom markets are, will be looking at Frankfurt on Thursday where the European Central Bank will again shed its lights on efforts to bring inflation under control. Will ECB President Christine Lagarde’s comments hold clues on where markets might move next?
Market bottoms have been called several times in recent months, but every time, financial markets - bonds as well as equities - found new lows. Inflation, both in the US and in Europe, proves to be persistent, leaving the Fed and the ECB with no other option than to continue hiking rates, for now.
Lagarde at her September meeting flagged clearly that the current series of rate hikes could last all the way to the end of March. Against that backdrop, an ECB rate hike on Thursday will be no surprise. Lagarde’s comments nevertheless will be scrutinised for clues on how the central bank assesses underlying economic conditions.
As soon as signs emerge that central banks believe rates are high enough to quell inflation, markets may be inclined to leave bearish sentiments behind. As long as markets are not convinced that central banks are effective, bulls will be kept at a distance.
All agree: 75 basis points
ECB watchers agree the bank on Thursday will announce an increase of 75 basis points as eurozone inflation remains persistently high. ING Bank, Pictet Wealth Management and ING Bank and others agree on 75 basis points as the ECB is highly determined to bring down inflation and inflation expectations.
“With a EUR/USD currently trading at 0.98 and inflation at around 10%, I expect the ECB to be quite hawkish and to deliver a 75bps rate hike,” said Vincent Juvyns, global market strategist at JP Morgan Asset Management.
“it is hard to see how the ECB cannot move again by 75bp,” said ING.
‘Near the bottom’
Although markets, as always, will carefully weigh the ECB›s monetary policy decision, next week’s meeting of the Federal Open Market Committee at the US Federal Reserve will be considered as more significant in terms of future market direction.
“The Fed will likely hike by another 125bps over the next two meetings,” said Juvyns. “This means that we may be near the bottom on financial markets but that we probably haven’t reached this bottom yet.”
At Pictet Wealth Management, head of macroeconomic research Frederik Ducrozet also expects the ECB will hike policy rates by 75bp at its 27 October meeting, with a commitment to additional tightening in the next few months to move its benchmark rates into neutral.
“We don’t expect much clarity on what it considers the ‘neutral rate’, but a growing consensus seems to be in favour of having the deposit rate at 2% by the end of the year (implying a 50bp hike in December), with a reassessment of the economic and inflation outlook in early 2023,” Ducrozet said in a note to investors.
UK experience makes ECB cautious
After years of stimulating the eurozone economy with qualitative easing, or QE, Ducrozet said that he expects the ECB will likely confirm on Thursday that quantitative tightening, also called QT, will start in 2023, once policy rates are normalised. Under QE the ECB made available billions in liquidity to banks at cheap, negative rates, easing money into the economy. Under QT, the ECB will do the reverse, withdrawing money from the economy.
“Crucially, QT will be a passive, gradual process,” he said.
“The recent events in the UK, which forced the Bank of England into a major U-turn on bond purchases, could be viewed as a useful reminder that any aggressive withdrawal of liquidity risks being highly disruptive for the bond market and the transmission of monetary policy,” Ducrozet said.
“We think that markets have got ahead of themselves,” said ING Bank, referring to QT. “Even if the discussion might have started at the ECB, with current financial stability risks, the recent UK experience and a very uncertain macro outlook, QT is still some way out.”
First ECB meeting ‘without’ a surprise
With a 75 basis point hike pretty much seen as a done deal, Dutch bank ING, in its note to clients, said ECB comments on excess liquidity, quantitative tightening and the “terminal” interest rate will be watched closely.
“Interestingly, since the start of the year, the ECB surprised to the hawkish side at every single meeting. (Thursday’s) meeting could be the first one without such a surprise as the ECB has finally managed to guide market expectations,” said ING. “A 75bp rate hike looks like a done deal and the reinstatement of a tiering multiplier could be the first answer to tackle excess liquidity. The ECB can simply not get enough of hiking rates aggressively.”