EVEN MORE RATE HIKES

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. While both the Eurozone and the UK are struggling with diminishing growth rates, policymakers remain squarely focused on taming multi-decade highs in inflation rates. Rate hike odds have jumped significantly for both the BOE and the ECB, with at least 150-bps worth of hikes discounted through the end of 2022.

BOE HIKE ODDS KEEP CLIMBING

The British Pound has proved resilient in recent weeks, no doubt fueled by the continued climb in BOE rate hike odds. UK inflation rates continue to edge higher, and with few signs that the rises in food and energy prices will halt anytime soon, rates markets are now their most aggressive they’ve been all year in terms of BOE hike odds.

BANK OF ENGLAND INTEREST RATE EXPECTATIONS (JUNE 23, 2022) (TABLE 1)

UK overnight index swaps (OIS) are discounting a 199% chance of a 25-bps rate hike in August (a 100% chance of a 25-bps hike and a 99% chance of a 50-bps hike). Rates markets are pricing another 50-bps rate hike in September, and again in November. The expected terminal rate for the BOE in 2022 now sits at 2.827%, up from 2.099% in mid-May.

IG CLIENT SENTIMENT INDEX: GBP/USD RATE FORECAST (JUNE 23, 2022) (CHART 1)

GBP/USD: Retail trader data shows 72.71% of traders are net-long with the ratio of traders long to short at 2.66 to 1. The number of traders net-long is 3.97% higher than yesterday and 4.83% lower from last week, while the number of traders net-short is 0.70% higher than yesterday and 15.62% higher 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.

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 GBP/USD trading bias.

TAMING INFLATION, PREVENTING FRAGMENTATION

Less than a week after the June European Central Bank policy meeting, the Governing Council reconvened in order to calm down Eurozone sovereign bond markets. Peripheral bond yields, particularly those in Greece and Italy, began to widen out rapidly versus their core (e.g. German) counterparts, rekindling fears of a revitalized Eurozone debt crisis. Yet since the ECB’s cryptic and vague remarks about preventing fragmentation in bond markets, Greek and Italian bond yields have calmed down in enough manner to keep fears at bay.

EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (JUNE 23, 2022) (TABLE 2)

Eurozone OIS are now discounting a 30-bps rate hike in July (295% chance of a 10-bps rate hike), in line with what most ECB policymakers have been suggesting in recent weeks. €STR, which replaced EONIA, is now priced for 156-bps more hikes through the end of 2022, up from 60-bps at the end of April. The expectations gap between the ECB and other major central banks continues to close, which should help insulate the Euro from more significant downside (so long as the rate hike pricing remains elevated).

IG CLIENT SENTIMENT INDEX: EUR/USD RATE FORECAST (JUNE 23, 2022) (CHART 2)

EUR/USD: Retail trader data shows 66.09% of traders are net-long with the ratio of traders long to short at 1.95 to 1. The number of traders net-long is 3.63% lower than yesterday and 11.98% lower from last week, while the number of traders net-short is 4.05% lower than yesterday and 19.48% 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.