The Federal Reserve's September meeting delivered an interest rate hike and unmistakably hawkish message last week, making it clear that the central bank is squarely focused on bringing down inflation.
Government bond yields worldwide continued their recent march upwards, now led by the short term, as the Fed, ECB, Bank of Japan and the Bank of England are all suggesting that their tolerance for above-target inflation is wearing thin. Stocks fell, and the US dollar rose against nearly every major currency worldwide. Both traders and economists (ourselves included) are busy revising their policy forecasts higher, and the lack of a resolution to the Iran conflict in the background only adds to the uncertainty.
The September central bank meetings are now out of the way, and the prospect for future policy rates has changed substantially in a direction that is unfavourable to risk assets generally, though resilient equity markets continue to trade not far from all-time highs. This week will be relatively light in data and monetary policy headlines. The main event will be the publication of the PMIs of business activity on Wednesday. We are optimistic and expect these numbers to validate the modest acceleration in growth that we have seen recently in the Eurozone, the US and the United Kingdom.
GBP
The Bank of England left rates unchanged at its September meeting, though its hawkish set of communications suggested that it was prepared to raise rates later in the year. The vote was split 6-3, which disappointed some of the market that had been anticipating a 7-2 outcome. The MPC's inflation projections were revised upwards, and several members noted that they could soon pivot towards a hike should the energy shock persist, which the bank explicitly said was likely. While we would argue that the domestic outlook, notably stable core inflation and a weakening jobs market, does not warrant higher rates, we now expect the bank to deliver an insurance hike at the November meeting.
Sterling got little help from this hawkishness and actually sold off following Thursday’s decision, which may partly be due to a classic case of “buy the rumour, sell the fact”, while most other G10 central banks are also pushing their expectations for policy rates higher. The recent tone in economic releases from the UK has been generally positive, and we expect this week's PMI numbers to validate this optimism, but the relentless rise of gilt rates is starting to introduce downside risks to public budget execution.
EUR
The eurozone economy continues to display remarkable resilience even in the face of the energy price spike. We expect this week's PMI indices of business activity to further confirm this resilience, and the manufacturing subindex specifically could surprise to the upside as German industry bounces back from transport difficulties caused by the low levels in the Rhine, as well as the continued diffusion of higher defense spending.
With headline inflation unlikely to provide the ECB with any respite, we now expect another hike from the central bank at its December meeting, which we think should help return the euro to a gradual path higher against the US dollar in the medium-term. In the near-term, however, the common currency could come under further selling pressure given surge in oil prices, which are worsening the bloc’s terms of trade, and the sell off in bond markets, which could drive further safe haven flows into the US dollar.
USD
The Fed's new chair Kevin Warsh is making his mark in the institution with a decidedly hawkish bent. His proposal for a 25 basis point hike was approved unanimously last week, and the short, succinct presser afterwards left markets in no doubt of what his priority is: to bring down inflation. The economic projections were also upbeat, while the median dots in the dot plot of interest rate projections were nudged higher than anticipated and consistent with one more rate increase in 2026 and no change in 2027 - a whole 50 basis points higher than the Fed had outlined at its June meeting.
Futures markets are now pricing in an additional hike as a certainty by December, with a 50/50 likelihood of a back-to-back hike in November. We expect one more hike this cycle, which should suffice given the relative lack of second-round inflation effects, unless the situation in the Middle East deteriorates markedly. However, our call remains highly data dependent and assumes that no further nasty surprises await in the next few inflation releases out of the US.
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