Central banks – Hawkish tilt.
This week, major central banks recognized inflationary risks and turned their tone more hawkish. In the US, the Fed doubled the pace of tapering and moved expectations for hikes to three in 2022. In UK, the Bank of England (BoE) hiked the deposit rates for the first time since the beginning of the pandemic. In Europe, the ECB announced the end of the PEPP program in March and a relatively fast taper of the APP program afterwards. In all three cases, commentary about inflation turned more hawkish. The Fed recognizes inflation risks as one of the main components of policy, after CPI printed close to 7% for November. In UK, the BoE now forecasts inflation to peak at 6% in February. In Europe, the ECO has recognized that inflation risks are on the upside. Economic risks from the pandemic are still cited, but they have been rebalanced in importance vis-à-vis inflationary pressures. We continue to see global inflation as the main risk for 2022 and think global central banks will continue to surprise on the hawkish side.
Markets – Hikes priced, just not everywhere.
Global markets are now pricing a good degree of tightening for 2022, but actual hikes can still create some adjustments in asset prices. In rates market, most of the re-pricing can happen in front-end Euro rates and long-end global curves. The ECB is still pushing back against hikes, opening the room for surprises next year. Global long end bonds remain well below the run (and forecast) rate of inflation, suggesting tightening can lead to a quick repricing. In US and UK, the front-end prices hikes already. If rates markets price a good degree of tightening, the same can’t be said for credit and equities. US and European HY spreads are far from 2018 highs, despite the year displayed a similar degree of hikes as we will see in 2022. In equities, Nasdaq valuations remain at the highs, despite a strong rates-sensitivity of index components. Emerging markets have been correcting in a more marked fashion (both in credit and equity), but fundamentals are more dependent on US monetary conditions. A few exceptions can be found among commodity exporters, energy-related and re-opening related credits, where rates sensitivity is lower and markets are already factoring in a negative scenario.
Emerging markets – Hawks vs Doves.
In emerging markets, most central banks remain hawkish. This week, Russia’s CBR hiked 100 basis points, bringing real rates in positive territory and taking a strong anti-inflationary stance. In Mexico, Banxico hiked 50 bp in one go despite market expectations for a 25 bp hike. This follows strong hikes in Brazil and Central-Eastern Europe last week. Overall, emerging markets central banks have been ahead of the curve vis-à-vis developed market ones, and fast and deep hiking cycles will help defending countries balance sheets from 2022 US tightening (though asset prices may suffer). One exception is Turkey, which cut interest rates by another 100bp this week despite increasing inflation and tightening global conditions. The Turkish lira spiral down has been accelerating and risks hurting the country balance sheet in the next few months. We have been negative on Turkey for the past few months and think we are getting close to a point of more material financial stress.
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