THINK Ahead: Markets get a fright, but central banks won’t spook that easily
The desk believes that recent market volatility, driven by plunging oil prices and significant tech stock sell-offs, will not compel central banks to alter their cautious approach to interest rate hikes. Per the full note by James Smith, while market participants are pricing in lower rate expectations, central banks in developed economies remain unconvinced that these factors represent a fundamental shift in the macroeconomic outlook. Notably, the probability of a Federal Reserve rate hike in December has fallen to 70%, down from earlier expectations, suggesting that markets are reacting more to sentiment than to solid data changes.
What the desk is arguing
The central thesis is that central banks, including the Federal Reserve and the European Central Bank, are likely to maintain their current trajectories despite recent market upheavals initiated by declining oil and tech stock prices. As noted in Smith's analysis, the narrative around energy prices lacks strong fundamentals to justify a significant shift in monetary policy right now.
The desk leans on the fact that interest rate expectations have decreased sharply, with rates projected one year ahead dropping almost 50 basis points in both USD and EUR since late September. This context, coupled with the historical timing of the Bank of England's decision to raise rates, leads to the conclusion that the markets may be overreacting.
This interpretation implies that current market adjustments could be premature; the fact that major central banks continue to express a deliberate stance on interest rates suggests that they are weighing broader economic conditions over immediate market pressures.
Where it sits in our coverage
Our internal consensus target for the EUR/USD pair is 1.075, with a range of 1.04 to 1.12. Key firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk view aligns closely with jpmorgan's forecast, sitting at the upper end of the predicted range, while it contrasts with bofa, which presents a notably more bearish outlook.
How other firms see it
Many firms are aligned in their cautious approach, anticipating that the central banks will not react hastily to short-term market fluctuations. In contrast, firms like bofa hold a more pessimistic stance, advocating for a tighter monetary policy sooner than anticipated.
Traders should closely monitor the EUR/USD pair, as its trajectory will be driven by forthcoming central bank policies, influenced heavily by current market volatility and energy price dynamics.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Central banks remain unperturbed amid recent market volatility.
- 02Market pricing reflects lower expectations for near-term rate hikes.
- 03Energy prices are experiencing significant fluctuation without strong underlying support.
- 04Interest rate trajectory will influence major currency pairs like EUR/USD.
Market implications
Watch the EUR/USD for movements in response to central bank speeches or data releases that could signal a reaffirmation of dovish policies. A key level to monitor is the 1.075 mark, which could serve as a pivot point if global economic data shifts significantly.
Risks to this view
A rapid escalation in geopolitical tensions or a surprising uptick in inflation could compel central banks to reconsider their positions, thereby invalidating our current outlook. Should energy prices rebound sharply, this may also lead to revised rate expectations.
Opinions Opinion by James Smith THINK Ahead: Markets get a fright, but central banks won’t spook that easily Published 09:21 Translate Tumbling oil prices and a brutal sell-off in tech stocks are making investors think twice about the direction of interest rates. But even after a roller coaster week, James Smith argues central banks will take more convincing They say timing is everything in finance. And the Bank of England’s timing this week was, let’s just say, far from ideal.
Oil is down 14% since last week’s close, natural gas 16%, and the Nasdaq more than 6%. That is an awkward backdrop for the Bank’s first rate hike since the Iran war. Sweden, Australia and the Czech Republic tightened too.
The market is clearly having its doubts. Neither an ECB nor a Fed hike is fully priced in for December, while the probability of the latter has fallen to 70%. Rates priced one year ahead have dropped almost 50bp in both dollars and euros since late September.
This all feels a bit premature. We have long thought central bank pricing looked too aggressive. But has the past week, and especially the US midterms, really changed the short-term policy outlook?
I’m not convinced. Interest rate expectations have fallen in the US and Europe Data as of 5 November Source: Macrobond, ING "> Data as of 5 November Source: Macrobond, ING Start with energy. This week’s sharp fall in prices hasn’t been built off much, let’s be honest.
Sure, gasoline prices mattered enormously to US voters and politicians have been surprisingly frank about that. But if diplomacy could not deliver a solution before the elections, why should it suddenly do so now the political clock has reset for two years? That does not mean oil cannot fall further.
Flows from the Middle East have been strong for weeks. And if the war doesn’t escalate, as many thought it would mere days ago, then our commodities team thinks the risk premium in prices can erode further. But as Bank of England Governor Andrew Bailey argued this week, it is too simplistic to focus only on the level of energy prices when officials meet in December.
What matters is what those prices tell us about the risk of further escalation. If prices fall while the geopolitics remain volatile, central banks have good reason to tread carefully. And don’t forget, there’s already plenty of inflation already in the system.
The crisis has reached sufficient longevity now to ensure that. Eurozone producer price inflation topped 11% in September. In the UK, I reckon energy is set to contribute more than one percentage point to inflation right through to next summer unless something changes dramatically.
Sources & References
How we cover this story