Rates Spark: The Fed Wagging The Dog

Even if other central banks opt for less hawkish communication this week, the Fed’s hawkish shift today will make it easier for its peers to follow suit. The trend is resolutely towards higher rates globally.

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The Fed’s Relevance To Non-USD Rates

USD markets are very much the tail that wags the global fixed income dog, with reason, and USD markets themselves are about to go through a sea change. This is not only due to a hawkish U-turn from the Fed that we're expecting today, but also an abrupt change in liquidity conditions thanks to accelerated tapering, and a raised debt ceiling. Do expect some spillover effects.

It is likely the Fed's sense of urgency is shared by its peers across the Atlantic

The first point of relevance is macroeconomic. Developed market central banks roughly share the same theoretical framework to study and anticipate economic developments. If the Fed feels compelled to change its mind in such a short timeframe, and make no mistake this is a swift change for a central bank, then it is likely its sense of urgency is shared by its peers across the Atlantic.

Today, The Fed Will Fire The Starting Gun On Higher Yields Globally

Image Source: Refinitiv, ING

The second point is financial. Through a number of channels, monetary decisions in the world’s largest economy do affect financial conditions elsewhere. For instance, a hawkish Fed boosting the dollar would ease financial conditions in large DM economies such as the eurozone, something the local central bank might want to counteract. Higher USD yields dragging their foreign peers higher should in theory cause the reverse but it also lowers the bar to tightening abroad if markets price it already.

Higher yields lower the bar to tightening abroad if markets price it already

This leads us to the last point: communication. It is much harder to blame a central bank for following in the Fed’s footsteps, even with a lag. A start to the Fed’s hiking cycle early in 2022 would inevitably start the countdown to other central banks following suit, even if only one year down the line in the European Central Bank's case.

This means that even if the Bank of England and ECB take decisions that could be construed as dovish this week, they are unlikely to scupper the move towards higher rates globally. For a more detailed analysis by jurisdiction, make sure you read our 2022 Rates Outlook.      

Today’s Events And Market View

The European November CPI reports released this morning are second readings and thus less liable to surprise markets. This leaves once again US data, namely retail sales, empire manufacturing, import prices, and the housing market index as the prime candidate to steer markets. It should be noted however that, given the proximity of the all-important FOMC meeting, appetite to enter new positions should understandably be limited.

The FOMC concludes its December meeting today with the release of a policy statement (expected to drop the reference to transitory inflation and announcing an acceleration of tapering), statement of economic projections (expected to upgrade inflation, downgrade unemployment, and signal earlier hikes), and a press conference. (to explain all of the above).