Whether the Fed raises its benchmark fed funds rate by 25bps or chooses to pause at tomorrow’s FOMC meeting, the Fed’s pace of tightening will fall behind the ECB’s robust 50bps hike for a second straight month. That shift has reduced the spread between each economy’s inflation-adjusted “real” rate and, therefore, will carry significant implications for the US Dollar and Euro in FX markets.
Core inflation remains more entrenched in the Eurozone than in the US, which gives the ECB greater incentive to continue tightening aggressively. Even in the face of Credit Suisse’s near-meltdown last week, the central bank’s Governing Council stuck to its rate hike plan as President Christine Lagarde insisted that the tools they utilize to maintain financial stability and price stability are not the same.
Related ETFs: Invesco CurrencyShares Euro Currency Trust (FXE), iShares MSCI Eurozone ETF (EZU)
The world will be watching this week’s FOMC meeting even more closely than usual, given the likelihood of a dovish shift by the Federal Reserve in the wake of a sudden strangling of liquidity throughout several pockets of the US and European banking systems. Earlier this month, hawkish comments by Fed Chairman Jerome Powell seemed to suggest a 50bps hike of the fed funds rate’s upper limit was back on the table after a prior hike of 25bps in February. MRP had been skeptical that a 50bps rate increase would ultimately come to fruition, even before the financial sector had started signaling distress, and fed funds futures markets have now totally priced it out. In fact, quotes from contracts trading on the CME show traders’ expect the next 25bps hike will be the last of this tightening cycle, implying a terminal rate of 5.0%. That is a material decrease from as high as 5.5% just a couple of weeks ago.
The Fed has had some time to consider how it will respond to the ongoing banking system tumult, but the European Central Bank (ECB) found itself in the eye of the storm last week as its Governing Council’s meeting coincided with a broad downturn in share prices of the continent’s banks and a potential collapse of Credit Suisse. With no time to change course, the ECB went forward with a planned 50bps hike, which solidified a more aggressive and sustained pace of tightening for the Europeans than that of the US. It’s likely that the ECB continues to tighten even further going forward, considering the region is…
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