(Bloomberg) - A dramatic week of central-bank meetings and economic data has changed the game for global rate-hike bets.
Not only are money-market traders boosting wagers on the number of increases by major central banks, but also the size of each potential move, reflecting the prospect that policy makers will front-load tightening cycles to combat inflation.
Strong U.S. jobs data on Friday fueled bets that the Federal Reserve will lift rates by half a percentage point in March. The Bank of England came within one vote of doing exactly that last week, causing traders to price in a 50% chance of such a move in coming months. European Central Bank President Christine Lagarde’s hawkish pivot re-calibrated the outlook in Europe, with focus turning to the potential for quarter-point increases instead of 10-basis-point intervals.
“The question is not what central banks will eventually do but what the market will price for them over the coming days and weeks,” said Mohit Kumar, a managing director of interest-rate strategy at Jefferies International, who doesn’t think the current rate-hike pricing will be delivered. “We are entering into a dangerous territory here where central banks have little idea what they are going to do in nine months or 12 months time.”
Larger rate hikes might boost central bankers’ inflation-fighting credibility, reducing the need for more increases further down the line. Policy makers are grappling with the fastest price increases in decades across the U.K., the U.S. and the euro area. And while some officials have already pushed back against aggressive tightening bets, that hasn’t stopped investors from hedging against shock-and-awe decisions in the months to come.
Sterling overnight index swaps are pricing around 37.5 basis points of tightening at the BOE’s March meeting, implying the market sees a quarter-point rise as guaranteed and a 50% probability of a half-point hike. Hedging for a 50-basis-point rise can also be seen in contracts linked to the BOE’s May decision.
In the U.S., traders increased bets the Fed will kick off its interest-rate hikes with the steepest increase in two decades. They were pricing in around 34 basis points of tightening for the central bank’s March decision on Monday, more than the typical 25-basis-point interval. Inflation data due on Thursday could move the needle one way or the other.
The ECB’s last five changes to its deposit rate have been in intervals of 10 basis points as it went deeper into negative territory. That had led to speculation that any tightening would be done in similar steps, though economist forecasts are now centering around quarter-point hikes. Borrowing costs are typically tightened in 25 basis-point steps and ECB Governing Council Member Klaas Knot said on Sunday he doesn’t “have reason to think differently this time.”
Some say front-end rates markets are getting ahead of themselves. The ECB’s emphasis on “gradual” tightening of policy implies only 10-basis-point hikes initially, according to Natwest Markets analysts including Imogen Bachra.
“Markets are trying to discount the worst case, but central banks do not like to create volatility and tend to be measured in their approach,” said Charles Diebel, head of fixed income at Mediolanum International Fund. “Will the ECB hike twice by 25 basis points this year? I doubt it.”
In recent sessions, central banks have been the driver of rates turbulence. One such measure in Europe, one-year options on two-year volatility, is at its highest since 2011. German two-year yields surged the most since 2015 after the ECB’s pivot last week. Euro short-term rate swaps currently price around 50 basis points of tightening this year from the ECB, implying two quarter-point hikes to bring its key rate to 0%.
“To gauge the fair market pricing is like solving one equation with two unknowns,” said Piet Christiansen, the chief strategist at Danske Bank A/S, who now sees a couple of quarter-point ECB hikes in December 2022 and March 2023. “The ECB is more data dependent than ever.”
By Greg Ritchie and James Hirai
