Central bank rate decisions weigh on investor optimism

The US Fed, Bank of England and ECB are all expected to deliver 50 basis point increases this week

A trader hangs Christmas decorations at the New York Stock Exchange. Markets opened in risk-on mode this week after Covid restrictions were eased in China. Reuters

It’s the last real trading week of the year before liquidity dries up through the Christmas and New Year period — and what a week it could turn out to be, with a raft of key central bank interest rate decisions expected to drive markets through to the end of the year and establish a trend for the first quarter of 2023.

The US inflation print was released on Tuesday. This will be followed by the Federal Open Market Committee's (FOMC) final rate decision and press conference for the year on Wednesday at 11pm UAE time.

The Bank of England’s rate decision will be announced at 4pm UAE time on Thursday, as well as the European Central Bank’s policy rate decision and press conference at 5.15pm.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

While markets opened this week in risk-on mode following the easing of Covid-19 restrictions in China, the gains were limited due to the key interest rate decisions.

With so much chatter of a global recession around the corner, actions and views of the trio of global central banks and what could be aggressive rate rises have tapered optimism this week.

If we start with the FOMC, a 50 basis point rise is well priced in.

Currently, there is a 78 per cent chance of a 50 basis point rise and a 21 per cent chance of a 75 basis point increase.

This is despite the fact that producer prices in the US rose slightly more than expected last month.

At the time of writing, Tuesday’s consumer price index (CPI) data for the US had not yet released.

However, a weaker-than-expected print will result in a more dovish Fed, which is good for markets but bad for the US dollar.

At a time when the dominant theme has been interest rates, only a figure that wildly beats expectations on either side could change the Fed’s current path.

Therefore, Fed chairman Jerome Powell’s speech on Wednesday should be closely scrutinised.

In his public address two weeks ago, Mr Powell said that while the rate of inflation may be slowing (dovish and bullish for markets), the Fed sees the terminal rate at a higher level than the 4.6 per cent projected in September (hawkish and bearish for markets).

It will be critical to see if Mr Powell and the Fed continue to maintain this view towards rates through to the second quarter of next year.

A projected terminal rate below 5 per cent will be viewed as dovish. It will be interesting to note the dot plot and how the voting changes.

Since September, markets have been poised for a rate cut in the fourth quarter of next year — how the voting changes and if this moves forward will bring added volatility to markets.

Across the pond, markets are pricing in a 90 per cent chance that the BoE will raise rates by 50 basis points to 3.5 per cent, the highest level in the UK since 2008.

The country has been combating a cost-of-living crisis amid soaring inflation. At the time of writing, last month's inflation print had not been released, but the October print was 11.1 per cent — five times more than the BoE’s target of 2 per cent.

Previously, the BoE said inflation should peak and start falling below 5.4 per cent next year and towards 1.5 per cent in 2024.

It will be interesting to see if this perspective changes, which will ultimately drive British pound pricing in the months ahead.

The ECB is also expected to deliver a 50 basis point increase on the back of 200 basis point rises since July.

This 50 basis point increase will lift the deposit rate to a revised 2 per cent.

The EUR/USD has been trading the past 10 days in a range between 1.0440 and 1.06. Below 1.0440, I expect to see next support at 1.04.

Overall, heading into the last few weeks of 2022, it would be prudent to await central banks’ policies before building a medium to longer-term view on markets.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers