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Whereas last week ended on the note that we may be approaching the point of peak hiking pace, this week brought a reality check. The Federal Reserve hiked rates by 75bp on Wednesday and the widely expected hike was accompanied by Powell’s hawkish message that financial conditions need to be tightened further. In contrast to any speculation around a possible Fed pivot, Powell stated clearly that 'it is very premature to be thinking about pausing' even if downside risks to growth are building. As a result, we adjusted our call to include a 50bp hike in February in addition to our earlier forecast of one more 75bp hike in December (see Research US – Fed review: Another hawkish 75bp hike – We now expect 50bp also in February, 2 November). The futures market is now pricing terminal rate at around 5.20%, 15bp higher compared to pre-meeting levels at 5.05%.
The Bank of England also hiked the bank rate by 75bp to 3.0% as expected on Thursday but with a dovish tilt compared to the Fed. Hence, we expect smaller hikes going forward and foresee the peak rate in February at 3.75%. Our view is for less hikes than the market is currently pricing in as we expect GDP data next week to confirm that the economy is already in recession. That being said, risks remain skewed towards additional hikes.
Norges Bank (NB) also delivered a dovish 25bp hike on Thursday, sending the sight deposit rate to 2.50%. While our call was for a 25bp hike, analysts and markets (37bp priced) were evenly split between 25bp and 50bp. This led to considerable market moves in rates and FX markets post announcement.
This week saw a sharp reversal in risk sentiment as premature optimism regarding the big central bank pivot faded. Broad USD as measured by the DXY index gained 1.9% while EUR/USD broke below the 0.98 level. At the time of writing on Thursday, both the US and German 10y yields were 15bp higher on the week. The easing in global financial conditions that we witnessed in October and that works against central banks’ efforts and interests now seems to have halted, which means hawkish communication still does the trick.
Next week, the focus will be on US midterm election on Tuesday. Republicans are favoured to win control of both house and senate, although the senate race remains a close call. If republicans win the senate with a slim margin or if democrats are able to retain the senate, market reaction should be quite muted, as major changes in fiscal policy would be difficult to pass. The (modest) risk-scenario for markets would be a clear victory for republicans also in the senate, as this could increase the risk of more expansionary fiscal policies amid the looming recession. We see the risk as fairly unlikely for now, however, as politicians are likely well aware of the inflation risks.
US October CPI will also be in focus next week. We are looking for another high print at +0.7% m/m / +8.0% y/y. There are also several Fed speeches scheduled throughout the week, which will of course be interesting after this week's meeting. Several ECB speakers on the wires as well starting with Lagarde on Monday. Friday brings UK GDP growth for Q3 which we expect will be in negative territory (-0.3% q/q), marking an official start of the recession. In China, we get exports on Monday and CPI data on Wednesday but these are unlikely to move the markets.
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