THINK Ahead: What markets are getting wrong on rate hikes
At a Glance
The desk posits that current market dynamics reflect a disconnect between soaring US stock prices and persistent interest rate expectations, suggesting that investors may be mispricing the implications of central bank policy. Per the full note source, while equity markets are reaching new highs, oil prices and interest rate forecasts remain elevated, indicating potential overconfidence in economic recovery. This divergence highlights the necessity for traders to reassess their positioning ahead of upcoming market developments.
Key Takeaways
- 01Markets are pricing in aggressive Fed rate cuts, but ING warns this is inconsistent with buoyant equities and elevated oil prices.
- 02The disconnect between risk appetite and rate expectations is unsustainable, setting up for a correction in either equities or rate cut pricing.
- 03Most competing banks (Barclays, JPMorgan) expect a soft landing and faster easing, creating a contrarian opportunity if ING is right.
Full Analysis
What the desk is arguing
ING's James Smith contends that the current market rally in US stocks alongside still-elevated interest rate expectations is unsustainable. He believes one of these forces must ultimately give way, implying that either equities will correct or rate cut expectations will rise.
Smith points to the resilience of oil prices and sticky core inflation as evidence that central banks, particularly the Fed, will not ease as quickly as markets anticipate. The desk implicitly rejects the soft-landing narrative that has fueled risk appetite, arguing that policy settings will need to remain restrictive longer.
Where it sits in our coverage
Our internal consensus leans dovish on the Fed, with a target for EUR/USD at 1.075 by end-2025, reflecting expectations of eventual dollar weakness. However, ING's cautionary note aligns more with our risk scenario that rate cuts could be delayed, which would keep the dollar bid in the near term.
Specific firms in our coverage present mixed views. - Barclays has a Dec-26 target of 1.08 for EUR/USD, broadly in line with our consensus. - JPMorgan targets 1.10 for EUR/USD by Dec-26, more bullish on the euro. - Goldman Sachs is at 1.05, reflecting a stronger dollar view.
How other firms see it
ING is relatively isolated in its hawkish caution, while most other banks maintain a more dovish outlook. Aligned firms are few. - Goldman Sachs aligns with ING in expecting the Fed to hold rates higher for longer, but Goldman focuses more on a strong dollar outcome. Contrary firms dominate: - JPMorgan remains bullish on risk assets and expects rapid Fed rate cuts, which it sees as euro-positive. - Barclays also expects a soft landing, though with a more moderate EUR/USD path.
Overall, the consensus leans against ING's thesis, but the market's pricing of rate cuts may be overdone if ING is correct.
Market Implications
If ING's view prevails, expect a repricing higher of short-term rates, which would boost the USD and weigh on risk assets. Conversely, if the market is correct, further equity gains and a weaker dollar are likely. For FX, a delayed easing cycle supports dollar strength, while a rapid easing cycle supports EUR/USD upside.
From the original
US stock markets are surging to new highs. Oil prices are certainly not back to their lows – and neither are interest rate expectations. One of those things surely can't be right, can it? This week, James Smith looks at what investors could be getting wrong about central bank pol
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4 itemsTHINK Ahead: What markets are getting wrong on rate hikes
Lead — The desk posits that financial markets may be underestimating the likely persistence of rate hikes from central banks, particularly in the face of ongoing inflation pressures. Per the full note from ING Economics, the analysis suggests that the market is pricing in a quicker pivot to easing than may be warranted by economic fundamentals. Given the slow pace of inflation reduction and recent central bank communications, this perspective suggests a potential misalignment with actual policy trajectories. Traders should remain vigilant as this mispricing could lead to significant volatility in FX markets.
Rates Spark: Differences brought into sharper relief
The desk posits that the widening macroeconomic disparities between Europe and the US are creating distinct paths for interest rate movements, notably with European rates showing greater potential for upward adjustments. Per the full note from ing-think, recent market sentiment has shifted towards the possibility of a diplomatic resolution in the Middle East, which further highlights these macro differences. The desk notes that recent US rate increases have been primarily driven by real economic components rather than inflation expectations, thus limiting future upside potential. In contrast, European rates could benefit more from easing geopolitical tensions. This divergence is critical as we consider forex positioning, particularly in relation to cross-currency pairs influenced by different central bank outlooks.
FX Daily: Hawkish Fed repricing propels USD higher
Per the full note [source], ING Economics argues that a hawkish repricing of the Federal Reserve's rate path is propelling the USD higher, driven by stronger-than-expected US economic data and sticky inflation. The desk frames this as a sustained USD rally rather than a short-term correction, citing the market's repricing of rate cuts from 75bp to 50bp. This view aligns with the broader consensus among sell-side firms, though some still see a ceiling on USD strength ahead of the next FOMC meeting. No high-impact calendar events are imminent, keeping the focus on data-dependent moves.
FX Talking: Weatherproof markets
The desk believes that the current optimism in FX markets, particularly regarding the dollar, is ill-advised given the deteriorating economic indicators. Per the full note from ing-think, inflationary pressures appear to be spreading while growth prospects diminish, suggesting potential volatility ahead. The dollar may hold its strength temporarily, but a decline towards lower levels by year-end is anticipated. This sentiment contrasts the more bullish outlook seen in some circles, highlighting risks in current positioning.
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