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By Padhraic Garvey, CFA, Benjamin Schroeder, Antoine Bouvet
The curves flattened as the hikes got closer
As the Fed moves on to the first of what we expect to begin an eight-fold 25bp hike cycle, it is useful to remind us of the role that central banks have in influencing long-term interest rates. In all likelihood, moving a more hawkish Fed, for example its point plot to get closer to the number of hikes we expect in this cycle, would push rates higher. The fact that the curve is already specifying a way very close to our own expected trajectory for the Fed Fund rates suggests that this would be far from a surprise.
A flat curve signals the market’s view of how far a central bank can go (Refinitive, ING)
In theory, his tone would also help inform markets about the fate of their balance sheet reduction plans – something that should in principle affect long-term interest rates more directly. In practice, it did not work out that way. The more hawkish the Fed has been in the last six months, the flatter the curve has become. This probably reflects in part the fact that interest rate policy remains the primary political lever of the Fed. There is also a timing argument. Balance sheet reduction is likely to be introduced over the second half of this year, making its impact three to six months away – an eternity on the financial markets.
Higher interest rates need economic optimism
This brings us to our main point. Central banks have a much better record of influencing cut interest rates, even in the age of quantitative easing (QE). Whether a hawkish central bank translates to higher long-end rates largely depends on market optimism that the economy can withstand higher rates. This may be less of a concern in the US than in the eurozone, but the energy crisis has eroded central banks’ confidence and ability to raise rates for long, hence the flat or reversed yield curves.
Economic anxiety means markets now see cuts in 2024 as an opportunity (Refinitive, ING)
Today’s Events and Market View
The main economic releases today will come from the US: retail sales and housing market index.
US events will culminate in the March FOMC meeting, statement of economic projections, and Powell’s press conference. Markets will pay particular attention to revised interest rate forecasts, the famous point plot, and growth forecasts as higher energy prices bite. Absent further upward surprises over inflation in the coming months, we believe that the markets view all dissent in favor of a 50bp hike as something that remains a marginal look.
Another question is whether the Fed decides to increase the interest rate on excess reserves and the reverse repo rate by the same 25bp as the target Fed fund range. Over time, we think the latter could be brought back into the line of the lower band of the range, pushing for more liquidity and other money market alternatives, but there is no need to rush that decision today.
In European hours, there is scarce data for markets to move, but Germany will auction 10Y debt.
Content disclaimer
This publication has been prepared by ING solely for informational purposes, regardless of a particular user’s means, financial situation or investment objectives. The information does not constitute an investment recommendation, nor is it an investment, legal or tax advice or an offer or request to buy or sell any financial instrument. Read more
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