More Shocks in the Offing as Central Banks Meet

Equity markets are back in the red on Thursday as investors reel from the nasty shock delivered by the Fed and look ahead to the plethora of central bank rate decisions on the agenda today.

Safe to say, investors didn’t see that coming. Two months of better-than-expected inflation data convinced them that the Fed would not only ease off the brake but signal it would do so more in the coming months.

Whether through complacency or a desperate desire to see value in equity markets, investors overlooked the concerns that have plagued policymakers for months. The fear of entrenched inflation has been a much greater concern, and it’s been better encapsulated in the jobs and wage figures than the headline inflation numbers that have spurred investors on recently.

Of course, that isn’t to say the Fed will ignore the progress we’ve seen in the inflation data. But perhaps that investors should give more consideration to the upside risks to it. While I still believe the Fed won’t raise rates as far as the dot plot indicates, the next hike may be another 50 basis points unless we see something more sustainable in the labor market and wage numbers.

Of course, markets have been ahead of the Fed several times this year, and the central bank may simply be pushing back as a means of preventing complacency from appearing in the markets, undermining its tightening efforts. But the case remains that the path back to 2% will likely be far less smooth than 7.1% and potentially just as disappointing sometimes. We should probably accept that now.

BoE to continue pushing back, ECB projections key

The question is whether other central banks will take a similarly hawkish position against the markets and ruin any hope of a Santa rally this year. Of course, that very much depends on the individual circumstances. Take the BoE for example; it has already been pushing back against market expectations but in a very different way, with the message from the MPC being that it doesn’t expect to tighten as aggressively as the economy falters.

The ECB faces other challenges, most notably the fact that inflation is still 10%, and it was very late to the party regarding raising interest rates. At the same time, the bloc faces a period of huge economic and energy uncertainty and probably recession.

The central bank is expected to slow the pace of tightening today following two consecutive 75 basis point hikes. Still, the economic projections will likely get the most attention as traders try to determine just how far the central bank plans to push rates.