Central Bank Meeting Fest!

Written on 13/12/2021 by Lukman Otunuga, Senior Research Analyst at FXTM

We know it’s the season to be jolly and all, but three central banks, two tough decisions and one Covid variant should continue to add some seasonal volatility to price action.

Having surged above 35, Wall Street’s fear gauge has dropped back below its long-term average around 20. The CBOE Volatility index (VIX) is now in neutral territory and indicates that market risks are low, in equity markets at least. This contrasts with the EUR/USD implied volatility, which has climbed to the highest this year as we approach this key week of central bank meetings.

Fed now on a faster path

With concerns in stock markets easing around the Omicron variant, the US Federal Reserve has been fairly explicit in looking through any associated problems concerning economic activity and new social restrictions. This means the Fed will likely confirm Chair Powell’s more hawkish recent message that inflation is more permanent, and policy will need to be normalised faster than previously thought.

Consensus sees a doubling of the tapering speed to $30bn a month which would end in March, and this opens the door to faster rate rises. We will also be on the look out for the new set of forecasts and “dot plot” as the Fed update their projections for the Fed Funds rate over the coming years. Two 25bp increases in the rate next year are expected, with a median projection of 0.625% at the end of next year.

Cautious ECB expected to wind down PEPP

The ECB faces questions over its asset purchases as this meeting was expected to be something of a “big bang”. Alas, with a fourth wave already sweeping the continent and Omicron simply exacerbating economic activity, the battle between the hawks and doves may continue to rage. Inflationary risks are evident, but the stuttering economy should see new forecasts push back inflation below 2% in 2023 and 2024, supporting the ECB’s overall patience stance with regard to rate hikes.

The hawks should be placated by the potential end to the emergency bond buying programme (PEPP) as scheduled in March. But this may simply see an extension of the main bond buying scheme (APP) . A highly accommodative stance is set to be maintained, and this should weigh on the euro in the quarters ahead as the Fed begins its hiking cycle.

BoE hike chances dwindling

With the emergence of the new variant, markets are dialling back their bets on the Old Lady raising rates this Thursday. There is now roughly a one-in-three chance of a 15bp move, compared to around 75% late last month before Omicron emerged. The outlook for the economy has been muddied by “Plan B” and more possible restrictions in the near future, even though the labour market and wage growth are currently strong.

The bank’s top hawk, Saunders, recently said he would prefer to wait for more evidence on the Omicron front before altering policy. A hawkish Fed and a BoE hold could see more near-term weakness in cable amid rising political risks. That said, this week’s expected elevated CPI and robust employment data may see the pound steady ahead of a possible hiking cycle by the BoE next year.

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