Fed and ECB – a counterpoint snapshot and show of commitment says Quintet’s chief economist

Daniele Antonucci, chief economist & macro strategist at Quintet Private Bank (the parent company of Brown Shipley) comments on the latest updates from the Fed and ECB and highlights market reactions:

Yesterday, both the Fed and the ECB delivered evidence of their commitment. The former to getting inflation back under control, and the latter to keeping financing costs for the weakest euro area members from rising excessively. Later today, markets will watch with great interest which path the Bank of England will take: we expect another quarter-point rate hike to a still low 1.25%.

Fed | Super-size me: As ‘leaked’, the Fed hiked its key policy rate by 75 bps, bringing it to a range of 1.50-1.75%. Changes in the wording of the policy statement laid out an even stronger commitment to bringing inflation back under control. This was reflected in the revised economic projections as well, which show the federal funds rate rising to 3.4% by year-end, up from 1.9% previously, though the neutral rate remains roughly unchanged at 2.5%. Growth projections for 2022 were cut by more than a percentage point, to 1.7%. If this slowdown begins to materialize, the Fed may become more hesitant regarding the last one or two hikes. In any case, despite the upwardly revised numbers, the projected peak rate remains relatively low compared to past cycles, with cuts to the federal funds rate planned for 2024 as inflation and growth return towards/below trend levels.

ECB | Blinking fast: Last week’s European Central Bank meeting was followed by a surge in peripheral bond spreads as markets reacted in disappointment to the absence of any concrete plans by the ECB to prevent fragmentation risk in the euro area. In what increasingly looked like a staring contest between policymakers and markets, the ECB blinked first. In an emergency meeting on Wednesday morning, the central bank announced a range of measured aimed at containing borrowing costs for the most indebted euro area members. Reinvestments from the pandemic-related emergency asset purchase program will be skewed towards countries such as Italy, Greece, Portugal and/or Spain, which should help limit further spread widening. Furthermore, work on a new “anti-fragmentation instrument” will be fast-tracked, though it is still not clear what form the tool will take, and how much of a backstop it will provide. Until then, debt sustainability concerns will remain most pressing for Italy and Greece. And even after that, the periphery’s underlying problems (high debt, low growth) will remain unresolved.

Market reaction: In Europe, markets breathed a sigh of relief. Bond yields fell and spreads compressed, with the 10y Bund falling 11 bps (to 1.63%), while Italy and Greece shed a whopping 36 bps and 46 bps, respectively. The EUR rose against the dollar as a fragmentation-risk premium was partially priced out, ending the day at 1.044 (+0.27%). With sentiment turning more supportive, European stocks gained on the day, led by Italy’s benchmark index, which rose 2.9%. In the US, comments by Chair Powell that 75 bps moves are unlikely to become common going forward provided a boost to equities, while the dollar index fell alongside short-end bond yields. The S&P 500 finished the day up 1.5%, while the curve steepened as two-year Treasury yields fell 24 bps to 3.25%.”