ECB – Dovish 50
The ECB hiked rates by 50bps to 2.5% on Thursday and guided for another 50bp in March, but did so with a less hawkish tone than expected.
The statement removed the wording that “inflation is far too high”, but added that they’ll “stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive”. In the press conference, the tone was much more dovish than the guidance communicated in December, with less emphasis on recent data improvements and core inflation stickiness.
Markets were positioned very short into the event, and rallied significantly as a reaction. Bund yields declined by 20bp, while Italian BTP yields declined by 40bps at the trough. When decomposing the Bund move, we saw that roughly three quarters, or ca. 15bps came from a repricing of front-end yields, as markets repriced the terminal rate down to ca. 3.3% and added pricing for rate-cuts from 2024 onwards.
ECB speakers tried to push back cautiously against the bullish reaction, highlighting that some still see a terminal rate of 3.5% and that core inflation remains concerning.
We don’t think the ECB can credibly push back from here, as they’ll need to wait for the new March forecasts. Those inflation forecasts are likely to be revised substantially lower amid falling energy prices, making a very hawkish outlook beyond March difficult.
The key question will be, how the council thinks about falling energy inflation versus sticky core inflation from here. Besides ECB speakers, our focus for this week lies on the publication of German CPI on Thursday, which may cause an upward revision for the Eurozone CPI.
Fed – End in sight
The Fed delivered the expected 25bps hike to 4.5-4.75% on Wednesday, and signaled that ongoing increases remain appropriate.
Most importantly however, the statement acknowledged the recent easing of inflation, and Powell mentioned disinflation 11x during the press conference. When further challenged on the point, Powell acknowledging that if inflation was to fall indeed as quickly as seen by markets, that this could result in a review of policy. In our view, Powell has now passed the ball back to the market, to interpret upcoming data which will include two more CPI reports and most importantly several labor market reports until March, which remain the key focus.
Last week’s JOLTS data showed the ratio of job openings to unemployed rose back to the highs at 1.9x, while the quits rate stayed uncomfortably high at 2.7%. While ADP employment and the employment cost index had initially indicated softer conditions, Fridays NFP at 517k and the ISM services index at 55.2 reversed the picture quickly and left US 10Y yields finishing the week around 3.5%, unchanged to the week before.
Markets are now assigning a 90% chance for a 25bp hike in March, and a 60% chance for a hike in May.
Markets – Hawks are out of town
The slowdown of global central bank policy has fueled a broad rally across equity and bond markets, as investors anticipate that slowing inflation means interest rates have peaked. Unlike last year, when policy makers chose to push back on the financial conditions easing to keep policy restrictive, the rally is now being validated as policymakers mostly avoid meaningful comments.
We take a more differentiated view: we agree that the Fed is close to the end of their cycle as inflation falls quickly this year, meaning US risk can reprice higher and US yields lower, assuming labour markets loosen eventually.
The rally in the Eurozone, however, looks excessive and more like an unwind of short positioning back to neutral levels, as the outlook for inflation remains more uncertain with core remaining sticky at 5.2%.
Over the next six months we’re closely watching labour market, inflation and growth data on both sides of the Atlantic. This will help us to understand how quickly central banks can end the hiking cycle and if any cracks in the economy emerge, as monetary policy lags come into effect.
Algebris Investments’ Global Credit Team
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