If there is one key theme for markets that we have right now it is that the world’s major central banks are starting to end their very loose monetary policy. During the COVID pandemic, central banks coordinated a move down to very low-interest rates. This was to make financial conditions as easy as possible. However, the COVID pandemic is increasingly being managed and central banks are now ending their QE packages and either hiking or moving towards hiking interest rates.
The implied rate from interest rate derivatives
This year interest rate derivatives are pricing in 5 rate hikes for the Fed, 2 for the ECB, 4 for the BoE, 6 for Canada, 6 for New Zealand, and 5 for the RBA. Central banks around the world are hiking interest rates in order to contain a surge in inflation. One of the main mandates of a central bank is to keep inflation rates manageable and raising interest rates is their only tool.
So what does this mean for FX markets?
It means volatility. The interest rate differentials between currencies create some of the best trading opportunities. As countries move faster than other countries on interest rate changes that create tradable opportunities, so watch out for this. Volatility is good for trading.
So what does this mean for other markets?
It also means we need to watch for a deeper stock correction. If interest rates rise too fast, too quickly then that can weigh on stocks. If growth is slowing, but interest rates are rising to contain inflation we could see a deeper sell-off in stocks. It is worth being aware that the Fed is only expected to change its mind on rate hikes if we see a greater than 20+% fall in the S&P500. That would take the price down to around 7600. Also, note that usually when the S&P500 falls greater than 20% a recession follows. The only time this did not occur was in 1987.
Finally, China’s 50 index is worth looking at. Unlike the other central banks which are hiking rates, the PBOC is cutting rates. This means that China’s 50 index offers excellent value at market, see below. The main risk to this outlook is if China’s growth slows further.