The End Of Pandemic-Era Easing?

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. Earlier this month, the ECB signaled that it was making minor recalibrations to its policy efforts in order to continue to support the Eurozone’s post-pandemic recovery. Now, just hours after the BOE’s September meeting, rates markets are beginning to price in a more aggressive rate hike timeline over the next six months.

After BOE, Rates Markets More Hawkish

The September BOE meeting produced a hawkish surprise, with a 7-2 vote that QE should remain unchanged. Two policymakers defecting towards more stimulus withdrawal caught markets off-guard, which have since recalibrated to anticipate a faster timeline on stimulus withdrawal over the coming months. The November Quarterly Inflation Report (QIR) may harken to the end of QE with rate hikes not too far around the corner.

Bank Of England Interest Rate Expectations (September 23, 2021) (Table 1)

UK overnight index swaps have been steadily advancing in recent weeks, and that continued today. After the August QIR, UK OIS were pricing in March 2020 as the likeliest period for the first-rate hike. In early September, UK overnight index swaps were suggesting that May 2022 – a meeting that will produce a new QIR – has the greatest odds of seeing the main rate liftoff. Now, after the September BOE meeting, rates markets are eying February 2022 for a 15-bps rate hike (71% chance).

IG Client Sentiment Index: GBP/USD  Rate Forecast (September 23, 2021) (Chart 1)

GBP/USD: Retail trader data shows 73.46% of traders are net-long with the ratio of traders long to short at 2.77 to 1. The number of traders net-long is 2.04% higher than yesterday and 56.35% higher from last week, while the number of traders net-short is 11.47% lower than yesterday and 37.80% 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.

QE May End, Low Rates Will Not

We’ve previously suggested that “‘lower for longer’ remains the mantra for the ECB.” We may have recently received some clarification on exactly what that means for ECB policy. According to anonymously sourced reports, ECB officials are readying to soon make an announcement that they will wind down their QE program perhaps as early as December (when the next Staff Economic Projections are released) thanks to expected Eurozone inflation rates running higher than even the ECB’s upgraded projections.

European Central Bank Interest Rate Expectations (September 23, 2021) (Table 2)

According to Eurozone overnight index swaps, the ECB will be keeping interest rates low for the foreseeable time horizon. Through September 2022, there is a 29% chance of a 10-bps rate cut. It remains the case that the ECB is solidly among the most dovish central banks among developed economies, offering little by way of support for the Euro as other central banks more aggressively signal their intention to wind down pandemic-era stimulus efforts.

IG Client Sentiment Index: EUR/USD Rate Forecast (September 23, 2021) (Chart 2)

EUR/USD: Retail trader data shows 60.27% of traders are net-long with the ratio of traders long to short at 1.52 to 1. The number of traders net-long is 4.18% lower than yesterday and 2.57% higher from last week, while the number of traders net-short is 1.63% lower than yesterday and 15.24% lower 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 less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.