Central Bank Watch Overview:
- Russia’s invasion of Ukraine continues to hold significant sway over how traders think the Bank of England and European Central Bank will proceed in the coming months.
- Rate hike odds have increased meaningfully for both the BOE and ECB in recent weeks, with BOE hikes expected at each meeting from May through November, while the ECB is expected to move as early as July.
- Retail trader positioningsuggests GBP/USD rates have a bearish bias while EUR/USD rates have a mixed bias.
Data Say One Thing, Policymakers Another
In this edition of Central Bank Watch, we’ll cover the two major central banks in Europe: the Bank of England and the European Central Bank. As multi-decade highs in inflation rates persist for both the Eurozone and the UK, rates markets have positioned themselves as if a series of rate hikes are just around the corner. But there is a notable divergence between what markets think and what policymakers are suggesting. As is often the case, the divergence in expectations is likely to provoke volatility in the associated currencies; here, the British Pound and the Euro.
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Mixed Signals from Policymakers
Various Bank of England policymakers have been offering mixed signals as it pertains to the scope and scale of further rate hikes. Just this week, BOE Deputy Governor Ben Broadbent noted that markets have become too reliant on central bank commentary for guidance on the path of interest rates. Instead, he suggested, markets should pay more attention to short-term data to gauge the likely path forward. With UK inflation rates at 30-year highs and UK GDP proving more resilient than anticipated, it may be the case that the BOE continues its rate hike efforts in the next few months, before pausing to assess whether or not UK inflation rates have started to recede.
Bank of England Interest Rate Expectations (March 31, 2022) (Table 1)
UK overnight index swaps (OIS) are discounting a 121% chance of a 25-bps rate hike in May (a 100% chance of a 25-bps hike and a 21% chance of a 50-bps hike). As BOE policymakers like Deputy Governor Broadbent caution for rates markets not to be too reliant on central bank commentary, rates markets see short-term data as warranting additional rate hikes over the next several meetings: 25-bps rate hikes are priced-in for June, August, September, and November.
IG Client Sentiment Index: GBP/USD Rate Forecast (March 31, 2022) (Chart 1)
GBP/USD: Retail trader data shows 70.10% of traders are net-long with the ratio of traders long to short at 2.35 to 1. The number of traders net-long is 5.45% higher than yesterday and 1.86% lower from last week, while the number of traders net-short is 1.09% higher than yesterday and 5.72% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests GBP/USD prices may continue to fall.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger GBP/USD-bearish contrarian trading bias.
Hawkish Expectations Return
There still seems to be a discrepancy between what European Central Bank President Christine Lagarde believes will happen with interest rates and what the market is currently discounting. After all, the head of the ECB continues to suggest that Eurozone inflation rates will peak over the coming months, and that any interest rate hikes will arrive later this year once asset purchases have ended.
But that prognosis is largely centered around the idea that the Russo-Ukrainian war continuing for several months. With ceasefire talks picking up in recent days, the removal of funding stresses on the European banking sector vis-à-vis sanctions levied against Russia could clear the path for the ECB to raise rates sooner – at least that’s what markets are expecting.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (March 31, 2022) (TABLE 2)
According to rates markets, Eurozone OIS are discounting at least a 10-bps rate hike in July (100% chance of a 10-bps rate hike and a 57% chance of a 20-bps rate hike), the most aggressive pricing in six weeks, when there was an 85% chance in June. €STR, which replaced EONIA, is priced for 50-bps of hikes through the end of 2022, back to the most aggressive rate hike pricing seen in 2022. While the elevated rate hike odds may be helping the Euro stabilize in the near-term, it warrants caution that if ECB President Lagarde is proven correct – that Eurozone inflation rates begin to subside in the coming months – the ECB will likely disappoint what have become aggressive rate hike odds.
IG Client Sentiment Index: EUR/USD Rate Forecast (March 31, 2022) (Chart 2)
EUR/USD: Retail trader data shows 56.85% of traders are net-long with the ratio of traders long to short at 1.32 to 1. The number of traders net-long is 6.15% higher than yesterday and 12.71% lower from last week, while the number of traders net-short is 5.13% lower than yesterday and 5.49% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EUR/USD prices may continue to fall.
Positioning is more net-long than yesterday but less net-long from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.
— Written by Christopher Vecchio, CFA, Senior Strategist
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